Welfare Econ Theory Flashcards
What does welfare economics seek to do?
Makes social welfare statements i.e. about wellbeing of society from different allocations of goods and services to individuals
What are the problems with comparing individual A and B to allocations R S and T?
- Utility cannot be compared across individuals as it is ordinal
- Ethical considerations so even if utility can be measured cardinally, there is the issue of how to treat different individuals e.g. begger vs millionaire might favour different allocation
What is a value judgement?
Statements that cannot be falsified by reference to facts, they are subjective and cannot be proven
What is the trade off for value judgements in welfare economics?
Trade off between usefulness and reasonableness i.e. if A is a dictator society can be treated as an individual but this is not reasonable.
What is the most widely used set of value judgements in Economics?
Pareto Postulates
What are the three Pareto Postulates?
a . Individualistic
b. Liberal
c. Pareto Criterion
What is the Individualistic Pareto Postulate?
Social welfare function is of form W = W (u1, u2 … un)
W is social welfare
u is utilities of individuals
SO social welfare as a function of the individual utilities who make up that society, lacking wider view
What is the Liberal Pareto Postulate?
Individuals are the best judge of their own welfare i.e. u1, u2, u3 with no moral considerations eg drugs give happiness
What is the Pareto Criterion?
Welfare W improves if at least one person is better off and no one is worse off, and vice versa.
What is a Pareto Improvement in welfare?
A reallocation of goods that improves welfare according to the Pareto postulates
Draw a Pareto Improvement in Consumption box
Pg 3
What is Pareto optimal / efficient?
An allocation from which no Pareto Improvement is possible
For a given output mix, where can you find Pareto Efficient allocations?
Only on the contract curve
What is social welfare function?
W = W (uA, uB)
What is an Iso Welfare line?
A line that shows combinations of individual utilities giving social welfare.
According to Pareto these lines slope downwards to the right.
Draw a Pareto Iso Welfare line and explain it
pg 4
Why can no shape be given to Pareto iso welfare lines?
Axes are measured in ordinal utility terms. Iso welfare lines are NOT the same as community indifference curves.
Do iso welfare lines intersect?
No it causes a contradiction. Show how C is a pareto improvement (page 5)
What is the upf?
Utility possibility frontier, showing the maximum utilities for A and B given society’s constraints.
What are societies constraints?
SCARCE RESOURCES
Factor endowments - fixed amount of L and K
Production function technologies - x and y
Utility function technologies - Ua and Ub
What must we do before we derive the upf?
Derive a utility possibility curve, which shows max utilities for a given configuration / product mix of the economy
Derive the UPC
Page 6
What varies from UPC to give UPF?
X and Y
Derive the upf
Page 6
Given any output mix, only allocations on utility possibility frontier are Pareto Efficient.
What is the welfare optimum?
The best position for society
Show welfare optimum / maximisation in a diagram (2)
Page 7
Comment on the Welfare Optimum
Welfare Optimum implies Pareto Optimality as the welfare optimum lies on the upf (the only way to make A better off is to make b worse off)
BUT
Vice versa does not hold as pareto optimality does not reveal which position is welfare preferred and it may be quite poor
Draw the diagram of the tangency condition being a necessary (only condition) but not sufficient condition
Page 8
