WELFARE ECONOMICS

Welfare economics is a branch of economics that studies the impact of factors like resource
allocation and economic policies on human and social wellbeing. 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.

Welfare economics forms an important part of microeconomics that analyses the impact of
resource allocation and economic policies and actions on the well-being of people. It studies
the structure of the economy and the markets in connection with the people and society. In
essence, it focuses on how various economic scenarios contribute to social welfare and how
the contribution varies.

The fundamental of welfare economics theory is all about the efficiency of resource allocation
and the corresponding well-being of society. It determines the economic policies for the
collective growth and development of the community. Therefore, the efficient resource
allocation and distribution of economic output are vital concepts of this domain. Furthermore,
understanding the various aspects of the welfare system helps economists evaluate public
finance, government policies, and welfare schemes.

Generally, academics describe the resource allocation process in connection with

The main objective is the overall welfare of society by studying the impact of different
economic policies on society as a whole. The study estimates the strength and weaknesses of
various economic policies and government initiatives using tools like cost-benefit analysis. It
deals with different income levels and throws insight into many issues related to a
community, region, or nation and its people. It also helps create and guide policies to solve
significant problems effectively.

IMPORTANCE

It reflects the fundamental ideology of the welfare of society: the health, happiness, and
financial well-being of the whole people. The growth measurement is not confined to GDP or
real income but includes welfare factors.

INVISIBLE HAND

• Invisible hand in economics refers to the unobservable market forces that lead
individuals’ actions out of self-interest to benefit society.
• The concept aligns with the capitalist economy. Therefore, it favors a free market
without government intervention, and supply and demand determine the market
equilibrium.

The idea in invisible hand in market economy is that competition and self-interest will
drive to offer the best products at the lowest prices to attract consumer demand, essential for
securing profits. All this will contribute to raising social welfare. However, the reason behind
this betterment of the human condition is ultimately selfish. Hence competition and self-
interest will create a productive society contributing to the economy.
WELFARE

Welfare refers to the well-being of an individual or group of people. When it comes to social
welfare programs, the government gives a payment to people who are in need. People who
are in need are generally living below the poverty line, and require some assistance to help
them pay for basic necessities. Most developed countries have some sort of welfare system;
however, what varies is how generous that welfare system will be to people. Some welfare
systems will offer more to their citizens than others. Therefore, economists will generally look
at common welfare programs and see who are the recipients and whether their well-being is
being improved. When a government has many welfare programs for its citizens, it is
typically referred to as a welfare state. There are three general goals of a welfare state:

1. Alleviating income inequality

EXAMPLE

A simple welfare economics example will be when a country thinks better for its citizens and
society. For example, a government can decide to spend its income for the betterment of
society through building hospitals, parks, community centers opening new markets and
welfare benefit schemes for unemployed people, child tax credits, and state plans for old age
citizens instead of spending the same funds on non-welfare projects.

France is one of the leading countries committed to social welfare. Nowadays, every country
is ensuring and still stuck in reviving their economy impacted by the COVID19 crisis, but
France has always been committed to the welfare of people. In 2019, the pre-pandemic times,
France had topped the list of social welfare spending calibrating its economy. The country
spent more than 30% of its gross domestic product on plans and welfare like a pension plan,
healthcare, and unemployment benefits. The US came second to the list.

PARETO EFFICIENCY

This microeconomic analysis leads to the condition of Pareto efficiency as an ideal in welfare
economics. When the economy is in a state of Pareto efficiency, social welfare is maximized
in the sense that no resources can be reallocated to make one individual better off without
making at least one individual worse off. One goal of economic policy could be to try to move
the economy toward a Pareto efficient state.

To evaluate whether a proposed change to market conditions or public policy will move the
economy toward Pareto efficiency, economists have developed various criteria, which
estimate whether the welfare gains of a change to the economy outweigh the losses. These
include the Hicks criterion, the Kaldor criterion, the Scitovsky criterion (also known as
Kaldor-Hicks criterion), and the Buchanan unanimity principle.

In general, this kind of cost-benefit analysis assumes that utility gains and losses can be
expressed in money terms. It also either treats issues of equity (such as human rights, private
property, justice, and fairness) as outside the question entirely or assumes that the status
quo represents some kind of ideal on these types of issues.
SOCIAL WELFARE MAXIMIZATION

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.

HOW IS ECONOMIC WELFARE DETERMINED?

Under the lens of Pareto efficiency, optimal welfare, or utility, is achieved when the market
is allowed to reach an equilibrium price for a given good or service—it’s at this point that
consumer and producer surpluses are maximized.

However, the aim of most modern welfare economists is to apply notions of justice, rights,
and equality to the machinations of the market. In that sense, markets that are “efficient” do
not necessarily achieve the greatest social good.

One reason for that disconnect: the relative utility of different individuals and producers
when assessing an optimal outcome. Welfare economists could theoretically argue, for
example, in favor of a higher minimum wage—even if doing so reduces producer surplus—if
they believe the economic loss to employers would be felt less acutely than the increased
utility experienced by low-wage workers.

Practitioners of normative economics, which is based on value judgments, may also try to
measure the desirability of “public goods” that consumers don’t pay for on the open market.

FIRST AND SECOND WELFARE THEOREM

Welfare economics is associated with two main theorems. The first is that competitive
markets yield Pareto efficient outcomes. The second is that social welfare can be maximized
at an equilibrium with a suitable level of redistribution.

ASSUMPTIONS
Welfare economics seeks to evaluate how economic policies affect the well-being of the
community. As a consequence, it is generally based on a lot of assumptions that include,
above all, taking individual preferences as a given.

IMPORTANCE OF WELFARE ECONOMICS

• It signifies the importance of optimal use of scarce resources to fulfill human needs.
• Favors the market structure nurturing maximum consumer surplus and producer
surplus.
• It addresses the market distribution and structures and their effect on all classes of
society.
• It ensures that the diverse problems are addressed and solved through resource
allocation instead of allocating resources and finances to areas in dire need or can fix
themselves.
• Throws insight into public finance, cost-benefit analysis, and the impact of
government policies.
• Prioritize policies and tools to guide the system to maintain the balance between
society and its citizens. The policies should have the potential to realize positive
economic and social outcomes for society.
• Economists formulate and guide policies to allocate funds and resources appropriately
to the promising areas for society.
• It signifies the importance of government intervention and invisible market
forces to stabilize the economy.

CRITICISMS

• Many economists believe that the study of this theory is based on several assumptions.
• The criticism further denotes a lack of clarity in the study and cannot be adopted
appropriately.
• Needs and values for goods vary between people. Hence the interpersonal utility
comparison process is complex.
• The life of people changes; lifestyle changes result in changes in social needs and
wants. Hence it is complex to capture the exact requirements and solutions.
• Means or methods to achieve the preferred ends is not perfectly known.
• Some opponents argue that increasing social expense for social development causes
an economic crisis.
• Opponents of the theory believe that it is flawed because of ignoring the political
determination of policies.