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Welfare Economics. naturalist: values derived from humans and non-humans (resilience of ecosystems) humanist: anthropological view (only humans have rights and duties)libertarian: individual rights and freedom is supreme and behaviour is assessed in terms of whether or not it respects those right
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1. Welfare Economics positive analysis: if 'X' happens under particular circumstances what are the implications for 'Y'.
normative analysis: what should be done, or how should we behave in a particular set of circumstances (value judgement, ethics => welfare economics).
Normative resource and environmental economics is predominantly founded in utilitarian ethics.
2 broad ethical systems: humanist and naturalist moral philosophies.
2. Welfare Economics naturalist: values derived from humans and non-humans (resilience of ecosystems)
humanist: anthropological view (only humans have rights and duties)
libertarian: individual rights and freedom is supreme and behaviour is assessed in terms of whether or not it respects those rights/freedoms (i.e. free action)
utilitarian: utility measures individual's pleasure or happiness (individuals experience pleasure and pain) aggregation of individual utilities = social welfare
3. Utilitarianism founders: David Hume (1711-1776), Jeremy Bentham (1748-1832), John Stuart Mill (1806-1873)
For utilitarians actions which increase welfare are right and actions that decrease it are wrong i.e., it is solely the consequences or outcomes of an action that determine its moral worth (in contrast, motivists judge actions according to its motivation). - The ends might justify the means.
!!!preferences => utility => consumer/producer surpluses!!!
4. Utility Function
cardinal measure of utility (kg, m, etc.)
ordinal measure of utility (ranking of numbers; 1, 2, 3,..)
with cardinal measuring, interpersonal comparisons are possible with ordinal measuring are not.
Pareto improvement: a change where at least one person gains and nobody looses.
Potential Pareto improvement: if gainers could compensate the losers and still be better off.
5. Utility Function if not cardinal then economists usually do efficiency rather then welfare analysis, or treat utility functions as if they were cardinal and do welfare analysis.
Criticisms of consumer sovereignty (preferences): do people always know what is best for them? do preferences truly reflect their interests (advertising)?
Amartya Sen (1987), people are both consumers and citizens. In regard to others, e.g. altruism, Sen distinguishes between sympathy and commitment. Sympathy: concerns are reflected in the arguments of utility function Commitment: concerns are based on ethical principles
6. Utility Discounting
and the continuous time version:
7. Why Utility Discounting ...some argue that consumers require incentives (e.g., interests) to exhibit positive time preferences, p > 0.
...others argue that the only ethically defensible position is that utilities attaching to each generation should be treated equally, p = 0. Individuals are consumers and citizens (Sen).
...another argument is that there is for every point in time in the future, a positive probability that the human species will become extinct, p > 0.
...or considering ethical prescriptions one need to examine their consequences in varying circumstances (optimal growth models).
8. Utility and Consumption Discount Rates
9. What Discount Rates should be used? Arrow et al. (1996) made a distinction between prescriptive and descriptive approaches.
for the prescriptive approach we need numbers for is a purely ethical question some guesstimation between 1 and 2 some guesstimation of future economic performance (e.g., the economy grows 4% annually)
for the descriptive approach there are markets in which individuals' inter-temporal consumption preferences are revealed (borrowing/lending) i.e., interest rates. In an ideal world the rate of interest = individuals' consumption rate of discount = marginal rate of return on investment.
10. Economic Efficiency An allocation of resources is said to be efficient if it is not possible to make one or more persons better off without making at least one other person worse off (applying the Pareto criterion).
Efficiency in allocation requires that three efficiency conditions are fulfilled: - efficiency in consumption,
- efficiency in production, and
- product-mix efficiency.
11. Efficiency in Consumption
12. A Set of Efficient Consumption Allocations
13. Efficiency in Production
14. Product-Mix Efficiency
15. Utility Possibility Frontier (UPF)
16. Maximising Social Welfare
17. Welfare and Efficiency
18. Inter-temporal Welfare Economics so far we have seen that efficiency and optimality at a point in time require equality conditions as between various rates of substitution and transformation (=> given ideal circumstances, a system of markets could produce an efficient allocation).
Two individuals (A, B) and two time periods (0, 1) with utility functions:
efficiency requires: 1. equality of individuals' consumption discount rates; 2. equality of rates of return to investment across firms; 3. equality of the common consumption discount rate with the common rate of return.
19. 21/05/2012 Valuation Methods 19 Alternative Allocation without SWF a reallocation is desirable if it increases somebody's utility without reducing anybody else's utility (Pareto efficiency).
Problem: - for policy analysis, there are a few re-allocations that do not involve some individuals gaining and some losing.
Therefore, welfare economists use Compensation Tests:
The Kaldor Compensation Test says that an allocation is superior to one, if the winner could compensate the loser and still be better off.
20. 21/05/2012 Valuation Methods 20 Potential Compensation Tests - Kaldor
21. 21/05/2012 Valuation Methods 21 Potential Compensation Tests - Hicks
22. 21/05/2012 Valuation Methods 22 Potential Compensation Tests
23. Potential Compensation Tests
24. 21/05/2012 Valuation Methods 24 Potential Compensation Tests - fairness
