Welfare Economic Foundations

Question 1

Value judgements made when writing social welfare as a function of individual welfare?

Answer 1

• individualism
• pareto principle
• consequentialism

Question 2

Why redistribute income?

Answer 2

• reduces inequality and so improves social welfare (assuming concave SWF)
• social insurance and income smoothing (piggy bank)
• poverty relief (Robin Hood)

Question 3

What can social planner NOT observe (but would like to)?

Answer 3

• utility
• inter-personal comparisons of utility
• lifetime income
• ability

Question 4

Arrow - 4 criteria that any satisfactory social choice function should obey?

Answer 4

PUDI:
P = Pareto principle
U = universal domain
D = non-dictatorship
I = independence of irrelevant alternatives

Question 5

1. What does Atkinson’s inequality measure do?

2. When is the index higher?

Answer 5

1. Links descriptive Lorenz curve to normative world of SWFs

2a. Deviation of individual incomes from average is greater
2b. Inequality aversion parameter is higher

Question 6

Under what condition can redistribution of income lead to a strict Pareto improvement (raising welfare of both people)?

Answer 6

1. Individual utility function of form: U(x,V)

(Where V=well-being of other members of society)

i.e. altruistic individual preferences

Question 7

Examples of when there is not necessarily a trade-off between equity and efficiency

Answer 7

1. social insurance (market failure of private insurance market)
2. Imperfect capital markets
3. externalities (e.g. altruism, crime)

Question 8

What is required to create a coherent social welfare function that meets Arrow’s 4 minimally demanding conditions?

Answer 8

Common scale to measure well-being, so that inter-personal comparisons of relative well-being can be made

Question 9

What is ‘full income’?

Answer 9

1. Full income = a measure of individual’s opportunity set (i.e. potential consumption, incl. leisure)
2. Full income = sum of money income + non-money income (incl. job satisfaction, value of own production, enjoyment of leisure)

Question 10

Why might differences in monetary income be misleading indicator of inequality?

Answer 10

1. Different choices and tastes
   (i) Those w/expensive tastes may choose to work longer hours than someone w/less expensive tastes
   (ii) Yet both maximising utility
2. Age
   (i) Difference in money income between 2 individuals may reflect life-cycle effect (no long-term inequality)
3. Time
   (i) If A and B have fluctuating incomes, then each year may be inequality, even though on average both earn same

Question 11

Advantages of Gini coefficient

Answer 11

1. Independent of level of absolute income

2. Compares each income w/every other income, not the mean

Question 12

Disadvantages of Gini coefficient

Answer 12

1. Ambiguous results when Lorenz curves cross
2. Gini coefficient is a weighted sum of people’s incomes w/weights determined by rank order in distribution, but this = entirely arbitrary SWF

Question 13

Criteria for assessing redistributive schemes?

Answer 13

1. Adequacy
   (i) Money – does it pay enough to allow people to buy adequate consumption bundle?
   (ii) Stigma – overall utility gain tempered by stigma of receiving benefits
2. Coverage
   (i) Horizontal efficiency – ‘avoiding gaps’ (benefits should go to all who need them)
   (ii) Vertical efficiency – ‘avoiding leakages’ (benefits should not go to those who don’t need them)
3. Costs

Question 14

Given private information problem, 2 possibilities for social planner? Problems with each?

Answer 14

1. Honest reporting of characteristics (individuals won’t have incentive to do this)
2. Inferring information from observed choices (but individuals may change behaviour, if they perceive link w/tax outcomes)

Question 15

Why might in-kind redistribution be superior vs cash transfers?

Answer 15

1. Public support

2. Self-selection

Question 16

What sort of comparability (of utility functions) does ordinal level comparability allow?

Answer 16

Allows ranking of consumers by utility level

Question 17

What sort of comparability (of utility functions) does cardinal unit comparability allow?

Answer 17

1. Effect of changes in utility

2. Can compare gains to 1 consumer against losses to another

Question 18

What SWF does ordinal level comparability generate? Example?

Answer 18

1. Positional SWF

2. Best-known = Rawlsian SWF

Question 19

What sort of comparability does a Rawlsian SWF require?

Answer 19

Ordinal level comparability

Question 20

1. What sort of comparability does a utilitarian SWF require?
2. Why?

Answer 20

1. Cardinal unit comparability

2. So we can compare the loss of 1 individual against the gain of another individual

Question 21

What does cardinal unit comparability require that we can measure?

Answer 21

1. Intensity of preferences

2. Trade-off between gains of 1 consumer and losses of another (on some sort of equivalent utility scale)

Question 22

What information is required for social planner to implement lump-sum taxation?

Answer 22

1. Select social optimum
2. Predict equilibrium that will emerge for all possible income levels
3. Know consumer’s utility functions
4. Know value of every consumer’s endowment (to calculate their pre-tax/transfer incomes and hence required lump-sum taxes/transfers)

Question 23

What is an Atkinson-style SWF?

Answer 23

Weighted utilitarian SWF (more weight given to utilities of lower-income agents)

Question 24

What is a good, fairly universally agreed-upon SWF to use?

Answer 24

Atkinson-style weighted utilitarian SWF (more weight given to utilities of lower-income agents)