Welfare economics is the study of how the allocation of resources and goods affects social welfare. This relates directly to the study of economic efficiency and income distribution, as well as how these two factors affect the overall well-being of people in the economy. In practical terms, welfare economists seek to provide tools to guide public policy to achieve beneficial social and economic outcomes for all of society. However, welfare economics is a subjective study that depends heavily on chosen assumptions regarding how welfare can be defined, measured, and compared for individuals and society as a whole.

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Course: Fundamentals of Economics (1103)
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2. Welfare economics is the study of how the allocation of
resources and goods affects social welfare. This relates directly
to the study of economic efficiency and income distribution, as
well as how these two factors affect the overall well-being of
people in the economy. In practical terms, welfare economists
seek to provide tools to guide public policy to achieve beneficial
social and economic outcomes for all of society. However,
welfare economics is a subjective study that depends heavily on
chosen assumptions regarding how welfare can be defined,
measured, and compared for individuals and society as a
whole.
It is a branch of economics that uses microeconomic techniques
to evaluate well-being (welfare) at the aggregate (economy-
wide) level.
Attempting to apply the principles of welfare economics gives
rise to the field of public economics, the study of how
government might intervene to improve social welfare. Welfare
economics also provides the theoretical foundations for
particular instruments of public economics, including cost–
benefit analysis, while the combination of welfare economics
and insights from behavioral economics has led to the creation
of a new subfield, behavioral welfare economics.

3. The field of welfare economics is associated with
two fundamental theorems. The first states that given certain
assumptions, competitive markets produce (Pareto) efficient
outcomes; it captures the logic of Adam Smith's invisible hand.
The second states that given further restrictions, any Pareto
efficient outcome can be supported as a competitive market
equilibrium.
There are related topics in practical welfare economics which
are only mentioned here. A reader interested in the practical
problems of evaluating policy alternatives can refer to entries
on CONSUMERS’ SURPLUS, COST-BENEFIT ANALYSIS and
COMPENSATION PRINC
There are two approaches that can be taken to welfare
economics: the early Neoclassical approach and the New
welfare economics approach.
The early Neoclassical approach was developed by Edgeworth,
Sidewick, Marshall, and Pigou. It assumes that:
 Utility is cardinal, that is, scale-measurable by observation or
judgment.
 Preference is exogenously given and stable.
 Additional consumption provides smaller and smaller
increases in utility (diminishing marginal utility).
 All individuals have interpersonally comparable utility
functions (an assumption that Edgeworth avoided in his
Mathematical ‘Psychics).
With these assumptions, it is possible to construct a social
welfare function simply by summing all the individual utility
functions.

4. 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 dispenses with cardinal
measures of utility: ordinal utility, which merely ranks
commodity bundles, such as represented by an indifference-
curve map is adequate for this analysis.
Vilfredo Pareto:
Economists defined social welfare as a sum total of cardinally
measurable utilities of different members of the society. An
optimum allocation of resources was one which maximized the
social welfare in this sense. V. Pareto was the first to part with
this traditional approach to social welfare in two important
respects.
The concept of Pareto optimum or economic efficiency stated
above is based on a welfare criterion put forward by V. Pareto.
Pareto criterion states that if any reorganization of economic
resources does not harm anybody and makes someone better
off, it indicates an increase in social welfare. If any
reorganization or change makes everybody in a society better
off, it will, according to Pareto, undoubtedly mean increase in
social welfare.

5. The compensation principle of the Hicks and Kaldor Criterion
states that “ if a change makes some people better off and the
others worse off, then that change will increase the social
welfare if those who gain from the change could compensate
the losers and still be better off.”
In other words, a change is considered to be an improvement if
the losers can not bribe the winners to not bring the change.
 The satisfaction of an individual is independent of other’s
opinions.
 In both production or consumption, externalities do not
exist.
 The individual’s taste remains constant.
 Ignorance of the issue of distribution.
 Utilities can be measured ordinally for a person.
 Interpersonal comparisons of utility are not possible.

6. Situations are considered to have distributive efficiency when
goods are distributed to the people who can gain the most utility
from them.
Many economists use Pareto efficiency as their efficiency goal.
According to this measure of social welfare, a situation is optimal
only if no individuals can be made better off without making
someone else worse off.
This ideal state of affairs can only come about if four criteria are
met:
 The marginal rates of substitution in consumption are
identical for all consumers. This occurs when no consumer
can be made better off without making others worse off.
 The marginal rate of transformation in production is identical
for all products. This occurs when it is impossible to increase
the production of any good without reducing the production
of other goods.
 The marginal resource cost is equal to the
marginal revenue product for all production processes. This
takes place when marginal physical product of a factor must
be the same for all firms producing a good.
 The marginal rates of substitution in consumption are equal
to the marginal rates of transformation in production, such as
where production processes must match consumer wants.

7. There are a number of conditions that lead to inefficiency. They
include:
 Imperfect market structures such as monopoly, monopsony,
oligopoly, oligopsony, and monopolistic competition.
 Factor allocation inefficiencies in production theory basics.
 Externalities
 Asymmetric information, including principal–agent problems
 Long run declining average costs in a natural monopoly.
 Taxes and tariffs.
 Government restrictions on prices and quantities sold and other
regulation resulting from government failure.
Welfare economics uses many of the same techniques as
microeconomics and can be seen as intermediate or advanced
microeconomic theory. Its results are applicable to macroeconomic
issues so welfare economics is somewhat of a bridge between the
two branches of economics.
 Cost-benefit analysis is a specific application of welfare economics
techniques, but excludes the income distribution aspects.
 Political science also looks into the issue of social welfare (political
science), but in a less quantitative manner.
 Human development theory explores these issues also, and
considers them fundamental to the development process itself.

8. :
However, Pareto efficiency does not provide a unique solution to
how the economy should be arranged. Multiple Pareto efficient
arrangements of the distributions of wealth, income, and
production are possible. Moving the economy toward Pareto
efficiency might be an overall improvement in social welfare, but
it does not provide a specific target as to which arrangement of
economic resources across individuals and markets will actually
maximize social welfare. To do this, welfare economists have
devised various types of social welfare functions. Maximizing the
value of these functions then becomes the goal of welfare
economic analysis of markets and public policy.
Results from this type of social welfare analysis depend heavily
on assumptions regarding whether and how utility can be added
or compared between individuals, as well as philosophical and
ethical assumptions about the value to place on different
individuals' well-being. These allow the introduction of ideas
about fairness, justice, and rights to be incorporated into the
analysis of social welfare, but render the exercise of welfare
economics an inherently subjective and possibly contentious
field.

9. Adam Smith was a Scottish philosopher, widely considered as
the first modern economist. Smith defined economics as “an
inquiry into the nature and causes of the wealth of nations.”
But in the modern definition, attributed to the 20th-century
economist, Paul Samuelson, builds upon the definitions of the
past and defines the subject as a social science. According to
Samuelson, “Economics is the study of how people and society
choose, with or without the use of money, to employ scarce
productive resources which could have alternative uses, to
produce various commodities over time and distribute them for
consumption now and in the future among various persons and
groups of society.”
.
Samuelson's definition tells us that economics
is a social science and it is mainly concerned
with the way how society employs its limited
resources for alternative uses. Samuelson goes
a step further and discusses how a society uses
limited resources for producing goods and
services for present and future consumption of
various people or groups.

10. Modern economic theory tends to
separate itself from classical economic
theory by looking at more than just the
source of production and the invisible
hand theory. Modern economics also
looks at items such as the role of
demand, money supply, and its effect
on growth or monetarism and free
trade. In some ways, modern economic
theory is a much more macroeconomic
study that looks at vast swaths of a
single economy. This does not mean
that an individual labeled a classical
economist does not favor these items;
it simply means that economics
changes through history, with the term
modern economics coming after the
period of classical economics. There is
still a distinct relationship between
these two schools of thought for
economic theory.
Money supply economics comes from modern economic
theory. Here, using a central bank to govern interest rates and
the amount of money in a market is important. This theory is
necessary to control inflation and manage growth in order to
not exceed upper limits in the economy.

11. Utility distribution is one of the vital role In modern economics.
In modern economics resources will be distribute among all
classes of people and they will use it properly. Every one have
the right to use the natural resources so that it can be proper
use. When it comes to resources it can be natural of artificial.
For example: Soudi Arab wants manpower for their development
work. Therefore they hire from people from many country. We
give our manpower resources in another country. In this way,
Soudi arab fullfil their utility and we get money from them.
That’s how people use highest use of natural resources and both
side got the chance for their utility and that’s how natural
resources use in highest way. If we talk about welfare
economics, there is term about utilities proper use. If we
campare it with modern economics both contain the same
ideals. Therefore we can say that Utility distribution in welfare
economics and modern economics both are same.

12. :
In modern economics, Keynes looked at the role of demand in a
market and what happened when there was too much supply
and not enough demand. Essentially, he thought the
government should step in and grease the market skids in order
to spur economic movement. This, in turn, would allow
companies with the supply to remain profitable and continue on
in their natural course of business. In this theory we know that,
if demand getting low and supply are high it will causes
Deflation. We know that deflation occurs when too many goods
are available or when there is not enough money circulating to
purchase those goods. As a result, the price of goods and
services drops. If we think about welfare economics, it’s talk
about the proper use of resources which will allow all the people
of a nation can use properly their resources. And govt. will
monitor the demand and supply market. In the theory of
modern economic Keynes, demand carp will be in down and
supply carp will be in up. So if we use this concept on modern
economics it will play a vital role in modern economics demand
and supply market. It can make balance in demand and supply.

13. Open markets and free trade between countries is another
modern economy theory tenet. In short, free trade is necessary
for a country to have a thriving economic center. Most countries
would desire an equal balance between imports and exports or
a situation where imports are far below exports because this
means more currency remains in the country. The ability to
move goods between domestic and other international markets
also allows for growth and expansion. In welfare economics
system there is a term about open market economics which is
totally match with modern economic free trading, import &
export terms. International trading is one of the most important
term in modern economics system which will help bonding
between nations. In welfare economics it’s not only for a
country, it is for all the nations around the world. So developing
countries, undeveloped country, all can taste the welfare
economy. Welfare economics help a nations market to higher
up. Now we are in the age of modern economy so welfare
economic system plays very important role in this term.

14. Some, such as economists in the tradition of the Austrian
School, doubt whether a cardinal utility function, or cardinal
social welfare function, is of any value. The reason given is
that it is difficult to aggregate the utilities of various people
that have differing marginal utility of money, such as the
wealthy and the poor.
Also, the economists of the Austrian School question
the relevance of Pareto optimal allocation considering
situations where the framework of means and ends is not
perfectly known, since neoclassical theory always assumes
that the ends-means framework is perfectly defined.
Some even question the value of ordinal utility functions.
They have proposed other means of measuring well-being as
an alternative to price indices, “willingness to pay” functions,
and other price-oriented measures. These price-based
measures are seen as promoting consumerism and
productivism by many. It should be noted that it is possible to
do welfare economics without the use of prices, however, this
is not always done.[1]
Value assumptions explicit in the social welfare function used
and implicit in the efficiency criterion chosen make welfare
economics a highly normative and subjective field. This can
make it controversial.

15. However, perhaps most significant of all are concerns about
the limits of a utilitarian approach to welfare economics.
According to this line of argument, utility is not the only thing
that matters and so a comprehensive approach to welfare
economics should include other factors.
The capability approach is a theoretical framework that
entails two core normative claims: first, the claim that the
freedom to achieve well-being is of primary moral
importance, and second, that freedom to achieve well-being
is to be understood in terms of people's capabilities, that is,
their real opportunities to do and be what they have reason
to value.[2]
References:
1. Dolan, Paul; Metcalfe, Robert (2008). Comparing
willingness-to-pay and subjective well-being in the
context of non-market goods.
2. Robeyns, Ingrid (14 April 2011). "The Capability
Approach". Stanford Encyclopedia of Philosophy.
Metaphysics Research Lab, Stanford University.
Retrieved 18 October 2020.
 Vilfredo Pareto - " “ Book
 Paul A. Samuelson – “ ” Book


16. welfare economics is the evaluation of the social desirability of
alternative economic states. An economic state is a particular
arrangement of economic activities and of the resources of the
economy. Each state is characterised by a different allocation of
resources and a different distribution of the rewards for
economic activity
The economist attempts to prescribe a method by which one
state of the economy can be transformed into another. Again,
policy measures are often available for changing an existing
situation. What is important to know in such cases is whether
the contemplated change is desirable. Assume that the
economy can attain multi-market (general) equilibrium at two
different sets of commodity and factor prices.
Since the desires of consumers and entrepreneurs are simul-
taneously satisfied at both equilibria, society cannot choose
between them, if at all, only on welfare grounds. The principles
by which such problem might be solved fall within the subject
matter and scope of welfare economics.
THE END