Welfare Economics


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Welfare Economics

  1. 1. Efficiency vs. Equality
  2. 2. Self-Interest and the Social Interest <ul><ul><li>When you buy a pair of shoes or a textbook , or even just take a shower, you express your view about how scarce resources should be used. </li></ul></ul><ul><ul><li>You make choices that are in your self-interest . </li></ul></ul><ul><ul><li>Markets coordinate your choices with those of everyone else. </li></ul></ul><ul><ul><li>Do markets do a good job? </li></ul></ul><ul><ul><li>Do they enable our self-interest choices to be in the social interest? </li></ul></ul><ul><ul><li>And do markets produce a fair outcome? </li></ul></ul>
  3. 3. Efficiency and the Social Interest <ul><ul><li>Allocative efficiency is one aspect of the social interest and the aspect about which economists have most to say. </li></ul></ul><ul><ul><li>An efficient allocation of resources occurs when we produce the goods and services that people value most highly. </li></ul></ul><ul><ul><li>Resources are allocated efficiently when it is not possible to produce more of a good or service without giving up some other good or service that is valued more highly. </li></ul></ul><ul><ul><li>Efficiency is based on value, and people ’ s preferences determine value. </li></ul></ul>
  4. 4. Efficiency: A Review <ul><ul><li>Figure shows an efficient pizza market: </li></ul></ul><ul><ul><li>1. Market equilibrium. </li></ul></ul><ul><ul><li>2. Marginal cost curve. </li></ul></ul><ul><ul><li>3. Marginal benefit curve. </li></ul></ul><ul><ul><li>4. When marginal cost equals marginal benefit, quantity is efficient. </li></ul></ul><ul><ul><li>5. Consumer surplus plus </li></ul></ul><ul><ul><li>6. Producer surplus is maximized. </li></ul></ul>
  5. 5. <ul><li>Efficiency of Competitive Equilibrium </li></ul><ul><ul><li>At the market equilibrium, resources are used efficiently. </li></ul></ul><ul><ul><li>Equilibrium quantity is the quantity that people value most highly. </li></ul></ul><ul><ul><li>To produce more of one good, some of another good that is valued more highly must be given up. </li></ul></ul><ul><ul><li>To produce less of one good, more of another good that is not valued as highly as the one forgone will be produced. </li></ul></ul>
  6. 6. <ul><ul><li>In a competitive market: </li></ul></ul><ul><ul><ul><li>The demand curve shows buyers’ marginal benefit. </li></ul></ul></ul><ul><ul><ul><li>The supply curve shows the sellers’ marginal cost. </li></ul></ul></ul><ul><ul><li>So at the equilibrium in a competitive market, marginal benefit equals marginal cost. </li></ul></ul><ul><ul><li>Resources are used efficiently. </li></ul></ul><ul><ul><li>So the competitive market is efficient. </li></ul></ul>
  7. 7. <ul><li>The Invisible Hand </li></ul><ul><ul><li>Adam Smith ’ s “ invisible hand ” idea in the Wealth of Nations implied that competitive markets send resources to their highest valued use in society. </li></ul></ul><ul><ul><li>Consumers and producers pursue their own self-interest and interact in markets. </li></ul></ul><ul><ul><li>Market transactions generate an efficient — highest valued — use of resources. </li></ul></ul>
  8. 8. Is the Competitive Market Fair? <ul><li>Symmetry principle : </li></ul><ul><ul><li>-The requirement that people in similar situations be treated similarly. </li></ul></ul><ul><ul><li>Two broad and generally conflicting views of fairness are: </li></ul></ul><ul><ul><ul><li>It’s not fair if the result isn’t fair </li></ul></ul></ul><ul><ul><ul><li>It’s not fair if the rules aren’t fair. </li></ul></ul></ul>
  9. 9. <ul><li>Not Fair if the Result Isn’t Fair </li></ul><ul><ul><li>Utilitarianism: </li></ul></ul><ul><ul><li>A principle that states that we should strive to achieve “the greatest happiness for the greatest number.” </li></ul></ul><ul><ul><li>To achieve this outcome, income must be transferred from the rich to the poor until no one is rich or poor. </li></ul></ul><ul><ul><li>Only if everyone’s share of the economic pie is the same as everyone else’s are resources being used in the most efficient way and bringing the greatest attainable total benefit. </li></ul></ul>
  10. 10. <ul><ul><li>The Big Tradeoff </li></ul></ul><ul><ul><li>A tradeoff between efficiency and fairness that recognizes the cost of making income transfers. </li></ul></ul><ul><ul><li>The tradeoff is between the size of the economic pie and the degree of equality with which it is shared. </li></ul></ul><ul><ul><li>The greater the amount of income redistribution through income taxes, the greater is the inefficiency —the smaller is the economic pie. </li></ul></ul>
  11. 11. <ul><ul><li>Make the Poorest as Well Off as Possible </li></ul></ul><ul><ul><li>Harvard philosopher, John Rawls, proposed a modified version of utilitarianism in A Theory of Justice (1971). </li></ul></ul><ul><ul><li>Taking all the costs of income transfers into account, the fair distribution of the economic pie is the one that makes the poorest person as well off as possible. </li></ul></ul><ul><ul><li>The “fair results” ideas require a change in the results after the game is over. Some say that this in itself is unfair. </li></ul></ul>
  12. 12. <ul><li>Not Fair if the Rules Aren’t Fair </li></ul><ul><ul><li>This idea translates into “equality of opportunity.” </li></ul></ul><ul><ul><li>Harvard philosopher, Robert Nozick, in Anarchy, State, and Utopia, (1974) argues that the rules must be fair and must respect two principles: </li></ul></ul><ul><ul><ul><li>• The state must enforce laws that establish and protect private property. </li></ul></ul></ul><ul><ul><ul><li>• Private property may be transferred from one person to another only by voluntary exchange. </li></ul></ul></ul>
  13. 13. The Sources of Economic Inequality <ul><li>An unfair distribution of Income and Wealth in the Economy. </li></ul><ul><li>1. Inequality in labor income- </li></ul><ul><ul><li>The more human capital (abilities, skills, etc.) a person possesses, the more income that person likely earns, other things remaining the same. </li></ul></ul><ul><li>2. Inequality in property income- </li></ul><ul><ul><li>It consists of income on assets like stocks, bonds, & real </li></ul></ul><ul><ul><li>estate. </li></ul></ul><ul><ul><li>The people at the very top of the income pyramid derive </li></ul></ul><ul><ul><li>most of their money from property income. </li></ul></ul>
  14. 14. Income Redistribution <ul><ul><li>The three main ways governments redistribute income are: </li></ul></ul><ul><ul><li>Income taxes </li></ul></ul><ul><ul><li>Income maintenance programs </li></ul></ul><ul><ul><li>Subsidized services </li></ul></ul>
  15. 15. <ul><li>Income Taxes </li></ul><ul><ul><li>The central government and most state governments tax incomes. </li></ul></ul><ul><ul><li>By taxing incomes of different levels at different tax rates, economic inequality can be decreased. </li></ul></ul><ul><ul><li>A progressive income tax is one that taxes income at an average rate that increases with income. </li></ul></ul>
  16. 16. <ul><li>Income Maintenance Programs </li></ul><ul><ul><li>Three major types of programs provide direct payments to individuals: </li></ul></ul><ul><ul><li>Social security programs </li></ul></ul><ul><ul><li>Unemployment compensation </li></ul></ul><ul><ul><li>Welfare programs </li></ul></ul>
  17. 17. <ul><li>Subsidized Services </li></ul><ul><ul><li>A great deal of redistribution takes the form of subsidized services—services provided by the government at prices below the cost of production. </li></ul></ul><ul><ul><li>An example is primary and secondary public education, as well as state colleges and universities. </li></ul></ul><ul><ul><li>The students at these institutions generally pay tuition and fees that range from 20 to 25% of the actual cost of educating a college student. </li></ul></ul><ul><ul><li>The families of these students enjoy a sizeable subsidy for acquiring human capital. </li></ul></ul>
  18. 18. <ul><ul><li>Redistributing income leads to a tradeoff between equity and efficiency, known as the big tradeoff . Programs to redistribute income are inefficient for three reasons: </li></ul></ul><ul><ul><li>The process of income redistribution uses up resources that could have otherwise been used for producing goods and services. </li></ul></ul><ul><ul><li>Redistribution of income requires taxes to be imposed on the economy, which generates a deadweight loss in the markets that are taxed. </li></ul></ul>
  19. 19. <ul><ul><li>Income redistribution decreases the incentives for : </li></ul></ul><ul><ul><li>1. Taxpaying workers to provide labor when leisure is a normal good (by decreasing income from work) and </li></ul></ul><ul><ul><li>2. Income assistance recipient’s to provide labor and earn income. </li></ul></ul>
  20. 20. <ul><li>“ ..the conflict between equality and economic efficiency is inescapable.” </li></ul><ul><li>-Arthur Okun (1975) </li></ul>
  21. 21. THANK YOU !!