ACCPT4- Welfare

Question 1

What is the First Fundamental Theorem of Welfare Economics (FFTWE)?

Answer 1

If all agents are price takers and markets exist for all commodities then market trading will result in an allocation which is Pareto efficient. Regardless of the initial endowment point, market forces will result in Pareto efficiency

Question 2

What is the Second Fundamental Theorem of Welfare Economics (FFTWE)?

Answer 2

If all indifference curves and isoquants are convex then for each Pareto efficient allocation there exists an initial endowment of resources such that the price mechanism will lead to that Pareto efficient outcome.

Question 3

What is an effect of the Second Fundamental Theorm of Welfare economics?

Answer 3

We can to some extent choose which Pareto efficient outcome we get by redistributing the initial allocation of resources through methods such as lump sum taxes and then letting markets do their work.

Question 4

What is the social welfare function sometimes known as?

Answer 4

Social indifference curves

Question 5

What is welfare a function of?

Answer 5

Welfare is some function of the utilities of the individuals in society:
W=f(UA,UB)

Question 6

What is the Benthamite SWF?

Answer 6

• It is irrelevant who has the utility, and the only relevance is the sum of total utility.
• Individual’s utility are perfect substitutes, hence we have straight line indifference curves
• This can give rise to corner solutions, where 1 individual may get no utility, but this is deemed as irrelevant if the sum of utilities is high

Question 7

What is the Bergson SWF?

Answer 7

• Convex indifference curves

* Satisfy conxexity (ie averages > extremes)

Question 8

What is the Rawlsian SWF?

Answer 8

• Characterised by right-angled indifference curves with their corner on the 45 degree line from the origin
• Individual utilities are perfect complements, and so welfare only rises if both individuals’ utilities rise
• The optimum will occur where individuals have the same utility:
W=min{UA,UB}

Question 9

List the 5 axioms in Arrow’s Impossibility Theorem

Answer 9

• Completeness
• Transitivity
• Pareto
• Non-dictatorial
• Pairwise Independence

Question 10

For Arrow’s Impossibility Theorem, what does the axiom “completeness” mean?

Answer 10

The social ranking can order all outcomes according to A≽B, B≽A or A∼B for all feasible outcomes

Question 11

For Arrow’s Impossibility Theorem, what does the axiom “Transitivity” mean?

Answer 11

The social ranking orders all outcomes consistently so that if A≽B and B≽C the A≽C

Question 12

For Arrow’s Impossibility Theorem, what does the axiom “Pareto” mean?

Answer 12

If, for all individuals in society, A≽B, then the social ranking yields A≽B

Question 13

For Arrow’s Impossibility Theorem, what does the axiom “Non-Dictatorial” mean?

Answer 13

No single agent’s preferences should determine the social ranking

Question 14

For Arrow’s Impossibility Theorem, what does the axiom “Pairwise Independence” mean?

Answer 14

The social ranking A≽B should not be dependent on the availability or non-availability of some alternative outcome C.

Question 15

However Arrow then went on to argue that there was in general no way to aggregate individual preferences to form social preferences without doing what and why?

Answer 15

Without relaxing one of these axioms, as for example under reasonable circumstances, majority voting could satisfy Pareto and Non-Dictatorial but fail to satisfy Transitivity and Pairwise Independence

Question 16

Does compensation rely on social welfare functions?

Answer 16

No

Question 17

What is Kaldor/Strong Compensation?

Answer 17

• Suppose a policy change leads to an outwards shift in the indifference curve, but the utility of individual B is harmed
• The 2nd Fundamental Theorem of Welfare Economics dictates that utility can be taken off individual A and given to individual B
• Thus we can gain a Pareto improvement from the new policy change
• Therefore the new policy improves welfare

Question 18

What is weak compensation?

Answer 18

The theory is similar to strong compensation, however the UPFs cross over, which allows Scotovsky reversal criterion. How can you say the new policy is preferable when point d is a Pareto improvement on b?

Question 19

What is the Scitovsky Critique?

Answer 19

• Neither weak nor strong compensation tell us anything about where we should be on a given UPF – only changes between them
• The weak compensation argument is entirely reversible (Scitovsky reversal criterion) – once you have established the new policy is preferable the entire reverse argument follows by observing d is a Pareto improvement on b.