3.1 Concept of welfare - Model Based Policy Analysis

Model Based Policy Analysis (Fach) / 3.1 Concept of welfare (Lektion)

what is welfare, social choice mechanisms

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What is welfare? Important question: Under which circumstances is one allocation of resources better than another? Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level. Attempting to apply the principles of welfare economics gives rise to the field of public economics, the 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 analysis
What is the difference between a positive and a normative analysis? Positive analysis: If "A" happens whta are the implications for "B"? Normative: what should be done, how should we behave in a certain situation? Keep in mind: Normative resource and environmental economics is predominantly founded in utilitarian ethics. There are different ethical systems
Which ethical systems do you know? Biocentrism: All living things have intrinsic value, regardless of their instrumental value. Ecosystems are intrinsically valuable but not inividual members. Anthropocentrism: Only humans have rights and duties (as individuals or communities). a) liberitarian: individual rights and freedom are surpreme and behavior is assessed in terms of whether or not it respects those rights and freedoms (i.e. free action). b) utilitarian: utility measures individual's pleasure or happiness. Aggregation of individual utilities = social welfare
Give a short explanation of neoclassical welfare economics. 1. Each individual is a fundamental entity of the society, its preferences count. 2. Individuals gain utility from consumption 3. Individuals make their choices rationally (homo oeconomicus) 4. The values/strenghts of utility are expressed by the market prices 5. The more individuals demand something or value the utility of something the higher are the price and WTP 6. The aggregation of the individuals utilities can be used to make decisions about the allocation of resources in a society
What is a utility function? What is an indifference curve? (link to climate) How can we generate a societal decision from individual preferences (x and e)? Consider a set of alternatives facing an individual, and over which the individual has a preference ordering. A utility function is able to represent those preferences. Different combinations of two bundles of goods that provide the same utility are displayed on indifference curves. Utility and environment: Utility function Ui(x,e) with x= goods and e= environmental quality --> when faced with trading off x and e a rational agent tries to maximize utility How to generate a societal decision Each individual has a utility function: UA(x) , UB(x) welfare: W= ?(??,??) weights for each indivual: W= β1?? + β2?? in an egalitarian society each weight is the same: W= UA+UB Keeep in mind: different welfare functions lead to different views on what society views as desirable
Explain the conflict arising from present consumption decisions. Discounting utility and consumption Decisions today (might) affect people in the future. That means welfare is intertemporal. Intertemporal welfare Two generations: 1 and 2 weights for summing utility over generations: Φ1 and Φ2 welfare: W= Φ1UA+Φ2UB Time discounting: weights are time discount factors Φ1= 1/1+p W=U1+ U2/1+p with p= social discount rate: if p> 0 future utility counts less conflict: Where to take values from? Φ: phi
What social choice mechanisms do you know? 1. Pareto Criterion 2. The Compensating Principle 3. Voting
Give a short explanation of the Pareto criterion. What is a Pareto improvement? 1. Pareto optimality underlies value judgements used to choose among alternative resource allocations with the greatest net benefits 2. net benefit = all benefits - all costs, with a) benefit = welfare gain and b) cost = welfare loss 3. individual preferences count! 4. current income distribution is desirable 5. Pareto criterion can be considered as social choice mechanism Pareto improvement If it is possible to make at least one economic entity better off by moving from state A to state B, without making anyone else worse off , state A is ranked higher by society than state B. In this case the movement from A to B is a Pareto improvement.
Explain the compensation principle as a societal choice mechanism. - Potential Pareto improvement - Possibility of transfer payments situation: Moving from state A to B. One person is better off, while another person is worse off solution: the person who is better off can compensate the person that is worse off condition: net benefit must be positive problem: transfers may not be feasable solution: the transfer payment only needs to be hypothetically possible, no actual compensation needs to be paid!
What are advantages and disadvantages of voting as a social choice mechanism? 1. (+) Basic problem of Pareto criterion is the non-comparability of many bundles which leads to incompleteness in the ordering of commodity bundles. voting is able to overcome this problem. 2. (+) Voting does not need unanimity 3. (-) a typical voting mechanism is the majority rule, BUT the majority rule does not represent the intensity of a persons preference or opinion (normally represented by WTP.
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What are the theorems of welfare? 1. Theorem: In a competitive economy, a market euilibrium is Pareto optimal. 2. Theorem: In a competitive economy, any Pareto optimum can be achieved by market forces, provided the resource allocations of the economy are appropiately distributed before the market is allowed to operate.