Week 3- Welfare economics Flashcards
welfare economics is..
study of how the allocation of scarce resources affects economic well being
consumer surplus
- the difference between price a consumer is willing to pay and what is actually payed
- a good measure of social welfare
producer surplus
-amount seller Is paid for good or service supplied minus cost of production (profit)
Total surplus
- consumer + producer surplus
- net benefit of the specific market to the economy
Spending on different sectors e.g education increases…
consumer and producer surplus, increasing welfare
Criteria for comparing economic welfare outcomes for alternative policies
- Pareto criterion
- Kaldor-Hicks compensation criterion
Pareto criterion
- is most unambiguous
- public program is considered desirable if at least one person gains while no-one loses
- most unlikely outcome^
Kaldor-Hicks compensation criterion
- More useful that Pareto in todays economy
- increase in society’s welfare occurs if the gainer from a policy could hypothetically compensate the losers ad still be better off than in the absence of the project
- not about equity, about efficiency
- compatible with making the poor still poorer as long as the rich gain enough to ‘theoretically’ compensate the poor.
- If compensation is actually paid the Kalder-Hicks compensation is equivalent to parents criterion (aka ‘potential Pareto improvement criterion).
Kaldor-Hicks improvement
a policy unambiguously increases total surplus
Draw: effect of fast-growing plantations on sawn wood to market.
Are consumers unambiguously better off?
Are producers unambiguously better off?
Is it a Kaldor Hicks improvement
- Supply curves shifts down to right
- Consumers unambiguously better of
- producers benefit ambiguous
- Kaldor Hicks improvement (society is better of, because total surplus is unambiguously higher)
- consumers could theoretically compensate the producers
draw: implementation of tax on imported steel levied on consumers
+
levied on producers
+
tax wedge for both, labelling new consumer and producer surplus
and deadweight loss
- levied on consumers, demand shifts down to left
- levied on producers, supply shifts up left.
- same equilibrium
- tax burden shared between both consumers and producers
deadweight loss
- loss of consumer and producer surplus from the implication of a tax
- the area of deadweight loss is where production and consumption used to exist, now doesn’t due to tax
- can be good (cigarettes)
welfare implications of taxation
market is worse-off, unless the tax revenue is spent on issues (e.g coral reef protection) that create benefits that outweigh the losses from the market
Determinants of deadweight loss size
- inelastic demand + supply: small deadweight loss
- elastic supply + demand: large
Adam Smith’s ‘Invisible hand’
- people acting in their own self interest tent to promote the social interest, as if led by an invisible hand
- by doing this, the market naturally moves to market equilibrium
