Welfare economics

Welfare economics is a branch of economics that uses microeconomic techniques to simultaneously determine the allocational efficiency of a macroeconomy and the income distribution consequences associated with it. It attempts to maximize the level of social welfare by examining the economic activities of the individuals that comprise society.

Two approaches

There are two approaches that can be taken to welfare economics: the Neo-classical approach and the New welfare economics approach.

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The Neo-classical approach was developed by Pigou, Bentham, Sidgwich, Edgeworth, and Marshall. It assumes that utility is cardinal and that additional consumption provide smaller and smaller increases in utility (diminishing marginal utility). It further assumes that all individuals have similar utility functions, therefore it is meaningful to compare one individual's utility to another's. Because of this assumption, it is possible to construct a social welfare function simply by summing all the individual utility functions.

Related Topics:
Pigou - Bentham - Edgeworth - Social welfare function

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The New welfare economics approach is based on the work of Pareto, Hicks, and Kaldor. It explicitly recognizes the differences between the efficiency part of the discipline and the distribution part and treats them differently. Questions of efficiency are assessed with criteria such as Pareto efficiency and the Kaldor-Hicks compensation tests, while questions of income distribution are covered in social welfare function specification. Further, efficiency need not require cardinal measures of utility: ordinal utility is adequate for this analysis.

Related Topics:
Pareto - Hicks - Kaldor

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