welfare_Econ.ppt
- 1. Welfare economic The generic term for the normative aspect of economics. The basic assumption underlying welfare economics are value judgments that any economists are free to accept or reject. There is no scope for testing the truth of such assumption, as compared to positive economics where in principle they can be subjected to empirical testing. Welfare economics is concerned with policy recommendations. It explores the ways of arriving at conditions such as social state A is to be preferred to social state B. The dominant school is the paretian one, sometimes described as the New Welfare Economics. The most important departure of Paretian welfare economics from the Pigovian tradition was the rejection of the idea that utility was cardinally and interpersonally measurable. In order to extend the applicability of the Pareto rule, hypothetical compensation test have been introduced. However, this requires that the utility be cardinally and interpersonally measurable.
- 2. Welfare economic Welfare economics is a branch of economics that uses microeconomic techniques to determine the allocation efficiency within an economy and the income distribution associated with it. Therefore, it is a methodological approach to assess resource allocations and establish criteria for government intervention. Welfare economics is concerned with welfare of individuals because individual is the basic unit of measurement. It also assumes that individuals are the best judges of their own welfare. Social welfare refers to the overall state of society. It is often defined as the summation of welfare of all the individuals in the society.
- 3. Welfare economic Welfare analysis is a systematic method of evaluating economic implications of alternative allocations. It answers the following questions: 1. Is a given resource allocation efficient? 2. Who gains and who loses under various resource allocations? By how much? Welfare function: For individual it is synonymous with Utility function. For society, the social welfare function is a relationship between the welfare of society as a whole and all the variables affecting the state of the economy and the quality of life.
- 4. Efficient outcome When there are no externalities, an efficient outcome occurs where the sum of consumers’ and producers’ surplus is maximized. Area under demand = gross benefits Area under supply = gross cost Social surplus = gross benefit – cost.
- 5. Monopolist: Under-buy and oversell P Q C D Pc Qc C MR Pm Qm A B Qc, Pc=under competition Qm,Pm=under monopoly Monopoly produces too little and charges too much. Welfare loss under monopoly is . ABC
- 6. Welfare under Monopsony • A monopsony is the only buyer in a market, so they under buy and under pay P Q D MC Pc Qc MO Pmn Qmn Qc, Pc=under Competition Qmn,Pmn=under Monopsony
- 7. Welfare under Middlemen • A middleman is the only buyer and seller of product. MO P Q D S Pmmb Qmm C E MR Pmms Qmm=middlemen output Pmms=price paid by middlemen to supplier Pmmb=price paid to middlemen by buyer
- 9. Sources of Market failure 1. Externalities; 2. Public goods; 3. Transaction costs; 4. Undefined/ unenforced property rights; and 5. Ignorance and uncertainty
- 10. Externality • A situation where one agent generates negative level of welfare for a third party then it is a negative cost or negative externality or external diseconomy. • If positive level of welfare is generated then it is a external benefit or positive externality or external economy. • Where property rights are not defined or defended … positive and negative “spill-over” or “externalities” • For a negative externality there will be “too much” production and prices will be “too low” i.e. not efficient.
- 11. How externality creates problem in market? Waste Disposal Bee keeping D S2 S1 D1 D2 S P2* P2* P1 P1 Q1 Q2 Q2 Q1 Clean Qty/ time Negative Externality Positive Externality
- 12. Condition for negative externality 1. An activity by one agent causes a loss of welfare to another agent 2. The loss of welfare is uncompensated. If loss of welfare is compensated then the effect is said to be internalized
- 13. Public good • An environmental asset is considered a pure public good or bad if its consumption is non-rivalry and non-excludable. Non-rivalry implies that consumption by one person does not reduce the quantity available for others like Oxygen Non-excludability means that individuals living in an area cannot be excluded from the good or bad effects of the environmental benefits or costs. Example: landscape view • No profit based incentive for production because of ‘free-riding’ • Insufficient production to be efficient.
- 14. Free ride in public goods • For markets to produce efficient outcomes, property rights must be: – Defined – Defended – Divestible • These characteristics ensure that the incentives for buyers and sellers are directed toward achieving efficient outcomes • When they are missing, markets will not achieve allocation efficiency • Market provides less of the public good than is socially desired. Therefore, people have incentive to free - ride
- 15. Property Rights Ostrom and Schlager, 1996 express Property rights as a bundle of rights with followings: 1. Rights of access ( Use/ Utility) 2. Rights of withdrawal (Profit) 3. Rights of mangt. (set up/ modify rules) 4. Rights of Exclusion (Exclude others) 5. Rights of alienation (lease/ inherit )
- 16. Property Rights and Cosean Bargaining Why do consumers and producers not have to pay for the external cost their activities generate? Why can they not extract payment from those enjoying the external benefits? Answer of those question often lies in the absence of property rights!
- 17. Coase Theorem Coase (1960) argue many types of externalities can be optimally controlled by creating property rights to relevant agents. Coase theorem concludes if property rights belongs to an agent and the cost of bargaining is zero then the bargaining between the parties results in the optimal control of externality
- 18. Cosean Bargaining MCA/MD MD MCA O E Pollution Where, MCA is Marginal cost of pollution abatement MD is Marginal Damage OE is optimal Pollution Load Interpretation: If MCA > MD then, Polluter has an incentive to offer bribe to the affected parties and affected parties has an incentive to accept bribe
- 19. Assumption of Coase Theorem 1. Property rights must be well defined. 2. Property rights must be enforceable and transferable 3. Parties involved in transaction must be well defined. 4. Property rights holder must be able to capture all benefits. 5. Transaction cost must be small.
- 20. Pareto optimal When the economy’s resources and output are allocated in such a way that no reallocation can make anyone better off without making at least one other person worse off then a Pareto optimum is said to exist. The concept was proposed by and is named after Vilfredo Pareto. A reallocation of resources which makes at least one person better off is said to be a Pareto improvement. Much of welfare economics is concerned with analyzing conditions under which a Pareto optimum may be achieved. Despite its analytical importance, the Pareto criterion is highly restrictive since it provides no guidance to choice between alternatives which involve one person becoming better off at the expense of another. In order to overcome this, some economists have sought to supplement the Pareto criterion with criteria based on distributional equity while others have considered the use of Compensation test.
- 21. Pareto Criterion According to Pareto, “ A decision related to a change that harms no one but benefits someone must be considered as an improvement.” This is the Pareto criterion for maximizing social welfare. AD = Community transformation; aQg = Choice of Consumption area a Point N = represents Pareto efficiency situation A B K E N R O I1 S E I2 N C1 C2 Q g O G F E D Cooking Gas
- 22. Pareto efficiency • No individuals can be made better off without making someone worse off • Maximum amount the gainers are prepared to pay is greater than the minimum amount the losers are prepared to accept, then an activity will contribute pareto optimality. • Maximum amount the losers are prepared to offer to the gainers in order to prevent the change is less than the minimum amount of gainers are prepared to accept as a bribe
- 23. Pigouvian Theory A.C. Pigou discarded the doctrine of consumers and Producers surplus and analyzed the welfare effects of Taxing increasing cost industries and subsidizing decreasing cost industries. Such a policy Pigou said would increase welfare by ensuring that the marginal social cost of producing an increment of output would be equalized across industries. His distinction between private and social costs and his proposed taxation remedy have formed the basis for the theory of externalities and his method for their elimination has become known as a Pigouvian Tax. In contrast to the Paretian welfare economics which has become popular Pigou used interpersonal comparisons of utility to make practical policy judgments. Pigou used his analysis to justify a transfer of wealth from the rich to the poor. He argued transfer of wealth to the poor would increase total welfare.
- 24. Pigouvian Tax/ Subsidy MSB (Marginal Social Benefit) MSC (Marginal Social Cost) MC/MB Tax MPC (Marginal Pvt Cost) MPB (Marginal Pvt Benefit) O Q* Qp Output Q*= Optimal level of output; Qp = Free market level of output ( With externality)
- 25. 6.2 Investment in Natural resources and its development in Nepal • Forests, water and soils are main Natural resources in Nepal • Forest and water are associated with land value • Land value can be accessed in terms of fertility and accessibility • Forests resources are depleted because of common pool nature • Nepalese government initiated forest resource management with the assistance of foreign donor