Pigou is best known for his work on welfare economics. He developed Pigou develops the concept of externalities at some length and uses. By Arthur C. Pigou. SHARE POST: WHEN a man sets out upon any course of inquiry, the object of his search may be either light or fruit—either knowledge for its. Libros de Segunda Mano (posteriores a ) – Literatura – Narrativa – Clásicos: La economia del bienestar -a. c. pigou – aguilar Compra, venta y.

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Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being welfare at the aggregate economy-wide level. Such functions typically include measures of economic efficiency and equity, though more recent attempts to quantify social welfare have included a broader range of measures including economic freedom as in the capability approach. The field of welfare economics is associated with two fundamental theorems. The first states that given certain assumptions, competitive markets produce Pareto efficient outcomes; [2] it captures the logic of Adam Smith’s invisible hand.

Attempting to apply the principles of welfare economics gives rise to the field of public economicsthe 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 analysiswhile the combination of welfare economics and insights from behavioral economics has led to the creation of a new subfield, behavioral welfare economics.

It assumes the following:. With these assumptions, it is possible to construct a social welfare function simply by summing all the individual utility functions.

Note that such a measure would still be concerned with the distribution of income distributive efficiency but not the distribution of final utilities. In normative terms, such authors were writing in the Benthamite tradition. It explicitly recognizes the differences between the efficiency aspect of the discipline and the distribution aspect and treats them differently.

Questions of efficiency are assessed with criteria such as Pareto efficiency and the Kaldor-Hicks compensation testswhile questions of income distribution are covered in social welfare function specification. Further, efficiency dispenses with cardinal measures of utility, replacing it with ordinal utilitywhich merely ranks commodity bundles with an indifference-curve map, for example. 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. There are a number of conditions that, most economists agree, may lead to inefficiency. To determine whether an activity is moving the economy towards Pareto efficiency, two compensation tests have been developed.

Any change usually makes some people better off while making others worse off, so these tests ask what would happen if the winners were to compensate the losers. Using the Kaldor criterionan activity will contribute to Pareto optimality if the maximum amount the gainers are prepared to pay is greater than the minimum amount that the losers are prepared to accept.

Under the Hicks criterionan activity will contribute to Pareto optimality if the maximum amount the losers are prepared to offer to the gainers in order to prevent the change is less than the minimum amount the gainers are prepared to accept as a bribe to forgo the change.

The Hicks compensation test is from the losers’ point of view, while the Kaldor compensation test is from the gainers’ point of view. If both conditions are satisfied, both gainers and losers will agree that the proposed activity will move the economy toward Pareto optimality.


This is referred to as Kaldor—Hicks efficiency or the Scitovsky criterion. There are many combinations of consumer utility, production mixes, and factor input combinations consistent with efficiency. In fact, there are an infinity of consumption and production equilibria that yield Pareto optimal results. There are as many optima as there are points on the aggregate production—possibility frontier. Hence, Pareto efficiency is a necessary, but not a sufficient condition for social welfare.

Each Pareto optimum corresponds to a different income distribution in the economy. Some may involve great inequalities of income. So how do we decide which Pareto optimum is most desirable? This decision is made, either tacitly or overtly, when we specify the social welfare function. This function embodies value judgements about interpersonal utility.

The social welfare function shows the relative importance of the individuals that comprise society. A utilitarian welfare function also called a Benthamite welfare function sums the utility of each individual in order to obtain society’s overall welfare.

All people are treated the same, regardless of their initial level of utility. One extra unit of utility for a starving person is not seen to be of any greater value than an extra unit of utility for a millionaire. At the other extreme is the Max-Min, or Ddel utility function Stiglitz,p [incomplete reference]. According to the Max-Min criterion, welfare is maximized when the utility of those society members that have the least is the greatest.


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No economic activity will increase social welfare unless it improves the position of the society member that is the worst off. Most economists specify bienestqr welfare functions that are intermediate between these bienestaar extremes.

The social welfare function is typically translated into social indifference curves so that they can be used in the same graphic space as the other functions that they interact with. A utilitarian social indifference curve is linear and downward sloping to the right. The Max-Min social indifference curve takes the shape of two straight lines joined so as they form a degree angle. A social indifference curve drawn from an intermediate social welfare function is a curve that slopes downward to the right.

The intermediate form of social indifference curve can be interpreted as showing that as inequality increases, a larger improvement in the utility of relatively rich individuals is needed to compensate for the loss in utility of relatively poor individuals. A crude social welfare function can be constructed by measuring the subjective dollar value of goods and services distributed to participants in the economy see also consumer surplus.

The first states that given certain assumptions, competitive markets price equilibria with transfers, e. Walrasian equilibria [3] produce Pareto efficient outcomes.

The second fundamental theorem states that given further restrictions, any Pareto efficient outcome can be supported as a competitive market equilibrium. Because of welfare economics’ close ties to social choice theoryArrow’s impossibility theorem is sometimes listed as a third fundamental theorem.

Utility functions can be derived from the points on a contract curve. Numerous utility functions can be derived, one for each point on the production possibility frontier PQ in the diagram above.

A social utility frontier also called a grand utility frontier can be obtained from the outer envelope of all these utility functions. Each point on a social utility frontier represents an efficient allocation of an economy’s resources; that is, it is a Pareto optimum in factor allocation, in production, in consumption, and in the interaction of production and consumption supply and demand.

In the diagram below, econmoia curve MN is a social utility frontier. Point D corresponds with point Boenestar from the earlier diagram. Point D is on the social utility frontier because the marginal rate of substitution at point C is equal to the marginal rate of transformation at point A.

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Point E corresponds with point B in the previous diagram, and lies inside the social utility frontier indicating inefficiency because the MRS at point C is not equal to the MRT at point A. Although all the points on the grand social utility frontier are Pareto efficient, only one point identifies where social welfare is maximized.

Such point is called “the point of bliss”. This point is Z where the social utility frontier MN is tangent to the highest possible social indifference curve labelled SI. Some, such as economists in the tradition of the Austrian Schooldoubt 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. Value assumptions explicit in the social welfare function used and implicit in the efficiency criterion chosen tend to make welfare economics a normative and perhaps subjective field.

This can make it controversial. 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 capabilities approach is an attempt to construct a more comprehensive approach to welfare economics, one in which an individual’s well-being and agency are evaluated in terms of their capabilities and functionings.

The economics of Welfare

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