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Unformatted text preview: Lecture 27: Welfare. c & 2008 Je/rey A. Miron Outline 1. Introduction 2. Voting 3. Rank Order Voting 4. Arrow Impossibility Theorem 5. Social Welfare Functions 6. Welfare Maximization 7. Individualistic Social Welfare Functions 8. Fair Allocations 9. Envy and Equity 1 Introduction The discussion of general equilibrium focussed on understanding the situations that lead to a Pareto e cient allocation. The focus on e ciency is potentially limited, for two reasons. 1. The assumptions necessary to guarantee Pareto e ciency are strong, so it is not obvious we should endorse market mechanisms as a good way of allocating resources based solely on the First Welfare Theorem. Markets might still be a rea- sonable method of allocating resources even when pareto e ciency is not guaranteed, under some circumstances. The view that &economic theory tells us markets are always e cient,however, is not right. 2. Even if we knew market allocations were always e cient or at least reasonably close, we might still prefer other mechanisms if society cares about more than just 1 e ciency (which it evidently does). In particular, most societies seem to care about distribution in addition to e ciency, and nothing guarantees that Pareto e cient market outcomes are desirable from a distributional perspective. For example, an allocation in which one person has all the goods is Pareto e cient. We have already discussed the relation between e ciency and distribution from one perspective: the Second Welfare Theorem. This tells us that we can, in principle, separate the issues of e ciency and distribution by using appropriate lump-sum taxes and transfers Even setting aside the practical di culties of adopting and implementing lump- sum taxes, however, the Second Welfare Theorem does not answer the question of which Pareto e cient allocation society should choose, assuming it wants such an allocation. The theorem also does not address the possibility that society might prefer a Pareto ine cient allocation if this achieves particular distributional goals. So, we now think about how society might make distributional decisions. Speci&cally, how should society think about the di/erent possible allocations of goods across the individual members of society, and how should it decide which policies to pursue? 2 Voting The natural way to proceed is to allow each individual to care not only about the goods he or she receives but also about the goods every other consumer receives. That is, I might have preferences not only about my own consumption of golf rounds and chocolate ice cream but also about your consumption of golf rounds and chocolate ice cream. Or, I might simply have preferences over how much total wealth each member of society should have. For some people, this might mean a preference for having more wealth than others, i.e., I am happier when my wealth rank or my relative consumption is higher. For other people, this might mean a preference for a more equaldistribution of wealth or consumption....
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This note was uploaded on 09/16/2009 for the course ECONOMICS 1010A taught by Professor Jeffreya.miron during the Fall '09 term at Harvard.
- Fall '09