This document provides an overview of welfare economics. It discusses key concepts like demand and supply curves, consumer and producer surplus, deadweight loss, price controls, externalities, and the invisible hand theorem. It also covers Arthur Pigou's work on externalities and the Pigouvian tax. The compensation principle is explained as a decision rule for selecting between social states. Two case studies on the compensation principle and gasoline taxes are also presented. The document concludes with a brief mention of Amartya Sen's contributions to welfare economics through his utilitarian approach.

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WELFARE
ECONOMICS
Subject: Managerial Economics
MMS Batch 1

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What is it?
• Branch of economics concerning “Social Welfare”
• Concepts
• Demand curve
• Supply curve
• Consumer and producer surplus

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Measuring the gain from trade
for consumers
• Demand curve = marginal
value curve
• Total value for consumers toP
purchase q units at price pd is S
the area underneath the
demand curve
• Total expenditure for
consumers to purchase q pd p
units at price pd equals
pd *q.
• Consumer’s surplus (CS) D
CS = Total Value –Expenditure
the area between the q Q
demand curve and the
price line

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Measuring the gain from trade
for producers
• Supply curve is the
marginal cost curve
• The total variable cost for P
the supplier to produce q S
units of output at price ps is
the area underneath of the
supply curve ps
• The total revenue for the
producer to produce q
units of output at price ps
equals ps*q D
• Producer’s surplus (PS)
q Q
PS=Total revenue - VC

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Dead Weight Loss
• A gain that could have been created but weren’t.
• A reduction in social gain because of policy intervention.
• The tax policy is not efficient in the sense that social gain
can be increased by dropping the tax.

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Price Control
• What is price control
• Price ceiling and price floor
• Binding and non-binding price floor/ceiling
• Examples
• Price floor- Agricultural products
• Price ceiling- Life-saving drugs

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The Invisible Hand
• Competitive equilibrium without government
intervention is often to be the most efficient.
• The invisible hand theorem essentially says that
“in competitive markets, people who selfishly
pursue their own interests end up achieving an
outcome that is socially desirable.”

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Externalities
• What are externalities?
• Types-
• Positive Externality
• Negative Externality
• Government can affect the outcome of an activity by its
policies. Example: Exhaust from automobiles, restored
historic buildings
• Negative externality (eg: Aluminium market) and positive
externality (eg: Education) w.r.t to the demand supply
curve

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Arthur Cecil Pigou (1877-1959)
• Marshall’s successor, master of neoclassical
economics.
• Chair of political economy at Cambridge from
1908 to 1943.
• Takes a softer view toward a larger role
government
• 1920, The Economics of Welfare
• Method
• Makes case for income distribution
• Theory of externalities

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Pigou Tax
• Tax applied to market activities that generate negative
externalities
• Example- Tax on tobacco, alcohol, etc.
• CSR (Voluntary)

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The Invisible Hand
• Competitive equilibrium without government
intervention is often to be the most efficient.
• The invisible hand theorem essentially says that
“in competitive markets, people who selfishly
pursue their own interests end up achieving an
outcome that is socially desirable.”

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The Compensation Principle
• Decision rule used to select between alternate
feasible ‘social states’
• “If there are net gains to any economic change
sufficient to compensate any losers, then it
should go ahead, regardless of whether or not the
compensation is actually paid”
• Welfare economics relates to cost-benefit
analysis
• Application to real life problems like free trade

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Case Study 1:
The Compensation Principle
• All clothing manufacturers shut shops in Italy
• All items physically produced in Asia (ex. Roma,
an Italian design house opening a manufacturing
facility in India- 1,000 new jobs in India and 200 in
Italy)
• Italy is now a booming design industry and a
regional hub of fashion design using IT- job
creation
• Both parties are better off in economic terms

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Case Study 2: Gasoline Tax
• Gasoline heavily taxed
• Reasons-
• Traffic congestion
• Accidents
• Pollution
• Consequences-
• Conservation of fuel
• Reduction in carbon footprint

15. Amartya Sen’s Contribution
• Outstanding economic theorist
• Nobel memorial prize (1998)
• Utilitarian approach
• Act consequantialism
• Welfarism
• Sum-ranking

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THANK YOU !