Welfare Econ Theory

Question 1

What does welfare economics seek to do?

Answer 1

Makes social welfare statements i.e. about wellbeing of society from different allocations of goods and services to individuals

Question 2

What are the problems with comparing individual A and B to allocations R S and T?

Answer 2

1. Utility cannot be compared across individuals as it is ordinal
2. 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

Question 3

What is a value judgement?

Answer 3

Statements that cannot be falsified by reference to facts, they are subjective and cannot be proven

Question 4

What is the trade off for value judgements in welfare economics?

Answer 4

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.

Question 5

What is the most widely used set of value judgements in Economics?

Answer 5

Pareto Postulates

Question 6

What are the three Pareto Postulates?

Answer 6

a . Individualistic

b. Liberal
c. Pareto Criterion

Question 7

What is the Individualistic Pareto Postulate?

Answer 7

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

Question 8

What is the Liberal Pareto Postulate?

Answer 8

Individuals are the best judge of their own welfare i.e. u1, u2, u3 with no moral considerations eg drugs give happiness

Question 9

What is the Pareto Criterion?

Answer 9

Welfare W improves if at least one person is better off and no one is worse off, and vice versa.

Question 10

What is a Pareto Improvement in welfare?

Answer 10

A reallocation of goods that improves welfare according to the Pareto postulates

Question 11

Draw a Pareto Improvement in Consumption box

Answer 11

Pg 3

Question 12

What is Pareto optimal / efficient?

Answer 12

An allocation from which no Pareto Improvement is possible

Question 13

For a given output mix, where can you find Pareto Efficient allocations?

Answer 13

Only on the contract curve

Question 14

What is social welfare function?

Answer 14

W = W (uA, uB)

Question 15

What is an Iso Welfare line?

Answer 15

A line that shows combinations of individual utilities giving social welfare.
According to Pareto these lines slope downwards to the right.

Question 16

Draw a Pareto Iso Welfare line and explain it

Answer 16

pg 4

Question 17

Why can no shape be given to Pareto iso welfare lines?

Answer 17

Axes are measured in ordinal utility terms. Iso welfare lines are NOT the same as community indifference curves.

Question 18

Do iso welfare lines intersect?

Answer 18

No it causes a contradiction. Show how C is a pareto improvement (page 5)

Question 19

What is the upf?

Answer 19

Utility possibility frontier, showing the maximum utilities for A and B given society’s constraints.

Question 20

What are societies constraints?

Answer 20

SCARCE RESOURCES

Factor endowments - fixed amount of L and K
Production function technologies - x and y
Utility function technologies - Ua and Ub

Question 21

What must we do before we derive the upf?

Answer 21

Derive a utility possibility curve, which shows max utilities for a given configuration / product mix of the economy

Question 22

Derive the UPC

Answer 22

Page 6

Question 23

What varies from UPC to give UPF?

Answer 23

X and Y

Question 24

Derive the upf

Answer 24

Page 6

Given any output mix, only allocations on utility possibility frontier are Pareto Efficient.

Question 25

What is the welfare optimum?

Answer 25

The best position for society

Question 26

Show welfare optimum / maximisation in a diagram (2)

Answer 26

Page 7

Question 27

Comment on the Welfare Optimum

Answer 27

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

Question 28

Draw the diagram of the tangency condition being a necessary (only condition) but not sufficient condition

Answer 28

Page 8