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Unformatted text preview: the individual consumers, then the usual procedure to get a welfare measure for the entire economy is to sum all individual welfare as follows: Consumer 1 Consumer 2 Consumer 3 . . . . Consumer n Entire Economy CV Calculation CV1 CV2 CV3 . . . . CVn CVsum = in CVi EV Calculation EV1 EV2 EV3 . . . . EVn EVsum = in EVi Do you think that there are any problems in this method of adding (aggregating) welfare like this? The answer is, perhaps, both yes and no! 213 On one hand, welfare measures are essentially income changes measured in dollar values, and hence, can be summed over individual consumers in the economy. For example, if we want to evaluate the welfare effect of a tax reform policy, we can calculate all the individual welfare effects and then add them up. On the other hand, if we have more than one consumer in the economy (and we do!), there will be those who gain in terms of welfare from the policy and those who will lose in terms of welfare from the policy. This makes it difficult to interpret the aggregation results. So, how do we know whether a policy change generates a society wide welfare improvement? To assert the welfare effect of a policy change, we can use the following compensation test: A policy change is a "potential Pareto improvement" if gainers can hypothetically compensate losers and yet on the whole remain better off. The change is "potential" in nature because the test is hypothetical (gainers are not actually compensating the losers for real) and it is a "Pareto improvement" because once "compensated" the losers are indifferent while the gainers are better off. [Potential Pareto Improvement]
Compensation Test => [Aggregate Welfare Change] As a result, a potential Pareto improvement implies a net aggregate welfare change CVsum < 0 EVsum > 0 The heading for this section is "Boadway's Paradox" so what is this paradox all about? While it's true that a potential Pareto improvement will lead to a net aggregate welfare change, Boadway's paradox warns about the potential danger in believing that the reverse will be true. The reverse is not necessarily always true. [Aggregate Welfare Ch...
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This note was uploaded on 05/25/2010 for the course ECON 301 taught by Professor Sning during the Spring '10 term at University of Warsaw.
- Spring '10