Welfare Economics and Welfare Analysis

Welfare analysis of the society is related to welfare economics. From the economic point of view former welfare economics refers to that subject which uses the techniques of microeconomics to analyse and evaluate the welfare at the economic or aggregate level.

What is Welfare Analysis?

In economics, welfare analysis is a method that helps the economists of an economy to evaluate certain kinds of policies that are implemented in the state and what kind of welfare or social benefit will there be for the people residing in that state where the policy is being implemented. It also mentions how the government can intervene in the process of social welfare of the people.

There are certain instruments in welfare economics that helps in the analysis of welfare: some of them are cost benefit analysis, better to efficiency and the invisible hands which is basically the demand and supply of our economy by Adam Smith.

Now there are certain ways in which the welfare analysis of an economy can be done.

The first method being the assumption of the social welfare, which involves the method of ordinal utility where the satisfaction level of the individual or consumer is measured based on their ranking of bundles of commodities. In other words, to achieve social welfare comma there is an important need off efficient allocation of resources and income in the hands of the to reach that state of social welfare.

Therefore, the welfare analysis or evaluation of social welfare is used or can be used to formulate various public policy that can help to achieve some important social and economic outcomes for the entire society to live in. However, it is important to know that welfare analysts are extremely subjective in nature as because this study is mainly dependant on what kind of tools is the economy defining for measuring the social welfare of the society.

One of the main important tools to determine that whether social welfare is being achieved or not, is the Pareto efficiency model. The Pareto efficiency situation is considered as an ideal state where social welfare can be achieved.

What does the Pareto Efficiency mean to an Economy?

It is referred to as an optimum situation where no individual or consumer can be better off without making at least one individual or consumer worse off or without any kind of loss faced by the individual or consumer. In simple words, Pareto efficiency refers to a condition in which all the consumers or individuals residing in an economy are having the optimum level of satisfaction or utility from the consumption of all goods and services. It is a kind of market situation as well. It is quite an ideological phenomenon because in the real world it is not possible that if an individual or a consumer is better off than the other consumer or individual in some way or the other must be worse off.

For example, suppose you go to the supermarket and there is only one packet of rice left. But there are two consumers to buy that including you. Now The thing is, if you buy that packet of rice the other individual will be worse off, and you will be better off. On the other hand, if the other individual buys that packet of rice, then you will be worse off, and the other individual will be better off. To reach Pareto efficiency, it is important that one more packet of rice must be available so that none of the individuals in the supermarket or none of the consumers in the supermarket are better off or worse off. There should be equilibrium let that be in terms of better or worse. Also, it can be said that there must be an equitable benefit for the consumer to establish that social welfare among them.

Welfare economics or the analysis of welfare is basically done for the well-being of the economy in such a way that is related to the resource allocation. The economic welfare is also taken into consideration when the study of welfare economics is done. The economic well-being is kept in mind while doing the asset allocation. This means that the set allocation should be done in such a way that the individuals residing in that particular economy are benefited from allocation that has been done.

Concept of Consumer Surplus

Concept of consumer surplus

Consumer Surplus is the difference between the price that the consumers are willing to pay and the equilibrium price or the market price or it can be said that the price at which the producers are willing to sell the product in the market. For example, presume a consumer went to the coffee shop expecting the price of 1 Cup of coffee to be ₹50. But when that individual reaches the shop, finds that the price of 1 Cup of coffee is ₹35. In this case the consumer is willing to pay or is ready to pay ₹50 for One Cup of coffee but the market rate of 1 Cup of coffee is ₹35. Therefore, this extra ₹15 is considered to be the consumer surplus.

Concept of Producer Surplus

Concept of producer’s surplus

Like the concept of consumer surplus, producer Surplus is the difference between the cost of production and the market price of the commodity that the producer is producing in each period. In other words, it is the price at which the commodity is to be sold in the market and the cost of production or the supply curve in general. For example, suppose that the cost of production off producing commodity is ₹100 but the market price of that same commodity is ₹120. This means that the consumers are willing to pay ₹120 for the product or commodity whereas the cost of production is only ₹100. Therefore, the producer necessarily needs to sell the product at ₹120 which gives him a surplus of ₹20. This is known as producer Surplus.

In case of social benefit of the society there should not be any kind of producer Surplus or consumers Surplus. This is because any one of the Surplus would mean that the other consumer or the producer is better off or worse off in a particular situation.

The impact of the welfare analysis is mainly on the government policies or the public policies that get formulated for the goal of achieving equitable distribution of income among the consumers and also for the social welfare which can come in the form of efficient allocation of resources or efficient output production that can maximize both utilities of an individual and the efficiency of resources.

Maximization of Social Welfare

Maximisation of social welfare

From the above discussion, it is seen that Pareto efficiency does not provide an efficient solution on how the economy should be arranged to get the optimal social benefit. Pareto efficiency talks about the ideal condition that can lead to words the maximum level of social benefit, but it does not give us a very specific idea that by what means this efficient situation in the market is achieved. To know what the economists of an economy should use to achieve the social welfare of all the individuals residing in that economy, the concept of social welfare function is used. In this case, maximize the value of the social welfare function to achieve that maximum level of benefits.

The result of this kind of welfare analysis is dependent mainly on the assumptions of how utility or satisfaction can be Compared or added between various consumers or individuals. The aim of most modern welfare economists in terms of welfare analysis for achieving the social welfare benefits or the optimal impact or the positive impact of the government policies or the public policy is to apply the idea of justice rights and equality to the mechanization of the market. This means that the market should operate in such a situation where both the consumers and the producers are plus will be maximized and where none of the individuals will be better off or worse off. Here, the market which is always efficient does not necessarily achieve the greatest level of social benefits. This can also be seen as a situation where in the production process if the producer is getting benefit from the producer surplus, the Labor should also be benefited in terms of wages that he acquires for being a part of the production process in producing that certain commodity.

But on contrary, it can be said that if individuals are in favor of a higher amount of minimum wage of Labor- this can reduce the producer's surplus. But if the producer also believes in this notion that a higher minimum wage can lead to the decrease in the producer's surplus then social benefit cannot prevail in the society because for one individual other individuals in some way or the other is worst off. In the end, the welfare analysts can be used to evaluate the impact, or the welfare analysis can be used to compare the base of the free market scenario, which operates freely on the theory of Adam Smith's invisible hands, with the scenario that helps in formulating the government policies or public policies which in turn provide social impact or benefits on the individuals or consumer residing in that economy.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for

  • B.A,
  • M.A.

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