Welfare Economics

263 Pages·1994·8.683 MB·English

by  Bhaskar Dutta (editor)

OXFORD IN INDIA READINGS
Themes in Economics
General Editors
* Kaushik Basu
* Prabhat Patnaik
WELFARE ECONOMICS
Edited by
BHASKAR DUTTA
DELHI
OXFORD UNIVERSITY PRESS
BOMBAY CALCUTTA MADRAS
1994
Oxford University Press, Walton Street, Oxford 0X2 6DP
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© Oxford University Press 1994
ISBN 019 563103 X
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Note from the General Editors
As economics advances rapidly and becomes both more mathematical
and statistically founded, the need arises to interpret its general prin­
ciples in the context of specific economies. In India, students are
taught the latest models but it is usually left to them or the rare teacher
to relate the models to the Indian context. The present series is an
attempt to rectify this lacuna. Each book in this series presents the
latest developments in a field and enunciates these in the context of
the Indian economy.
The series was conceived with senior undergraduate and post­
graduate students in mind. The aim is to provide accurate and interest­
ing books with contributions from leading economists. While each
book has a volume editor, we—the general editors-^work with the
volume editors in order to try and maintain some common norms and
standards for the series as a whole.
Initially there was a third general editor, the late Sukhamoy Chakra-
varty. He was actively involved in the planning of the first few books
in this series; and was a great source of inspiration to us till the last
days of his life.
Kaushik Basil
Prabhat Patnaik

Contents
List of Contributors
Introduction
Bhaskar Dutta
Market Failure and Information
Dilip Mookherjee
Efficient Resource Allocation
under Increasing Returns
Rajiv Vohra
Optimal Taxation and India:
A Review of Theory and Applied Work
M.N. Murty and Pulin Nayak
Price and Quantity Controls:
A Survey of Some Major Issues
Debraj Ray and Arunava Sen
Some Non-Welfaristic Issues
in Welfare Economics
Prasanta K. Pattanaik
Name Index
Subject Index
Contributors
Bhaskar Dutta
Indian Statistical Institute, Delhi
Dilip Mookherjee
Indian Statistical Institute, Delhi
Rajiv Vohra
Brown University, USA
M.N. MURTY
Institute of Economic Growth, Delhi
Pulin Nayak
Delhi School of Economics, Delhi
Debraj Ray
Boston University, USA
ArunavaSen
Indian Statistical Institute, Delhi
Prasanta Pattanaik
University of California, Riverside, USA
Introduction
Bhaskar Dutta
Economics has always been concerned with prescriptions for public
policy. Any prescription or recommendation of a particular policy must
ultimately be based on an assertion that the proposed change will
increase the ‘welfare of the society*. Assertions of this nature involve
knowledge of two distinctly different kinds. First, how will the pro­
posed policy change affect ‘relevant’ economic variables? Second,
how will changes in these economic variables affect social welfare?
An answer to the first question is provided by the body of knowledge
encompassing positive economics. Welfare economics, on the other
hand, is concerned with various aspects of the second question. In
particular, what aiy the components of social welfare? What is the
meaning of maximizing or even increasing social welfare? Can one
formulate (simple) sufficient conditions for an increase in social wel­
fare?
A. Bergson’s notion of an (ordinal) social welfare function1 provid­
ed a framework within which various views on social welfare can be
accommodated. Let a social state be a complete description of the
amount of each type of commodity held by each individual, the
amount of labour to be supplied by each individual, the amount of
each productive resource invested in each type of productive activity,
the structure of rights in society, and so on. In other words, the
description of a social state must include eveiy variable which can
conceivably affect the community’s welfare. Letting X denote the set
of social states, a Bergson social welfare function W assigns a numeri­
cal social utility or welfare, W(x)9 to each social state x in X. The aim
of society is then described by saying that it seeks to maximize social
‘See Bergsoo (1938).
2 BHASKAR DUTTA
welfare subject to the relevant technological, resource, and institutional
constraints.2
Bergson assumed that W(x), the value of social welfare in state x,
would ‘depend on all the variables that might be considered as affect­
ing welfare’ (p. 417). Of course, this does not impose any constraint on
the functional form of W. The construction of a particular social
welfare function must be a normative procedure since it involves
making value judgements. For each set of value judgements adopted, a
different social welfare function will result. Hence, there is no sense in
which the welfare economist can talk of a ‘unique’ or objective social
welfare function.
Is there a systematic way of choosing a particular Bergson-Samuel-
son social welfare function? The work of Arrow (1963) can be seen as
an attempt at answering this question. Arrow defined a Social Welfare
Function—henceforth SWF (to be distinguished from the Bergson-
Samuelson swf) as a functional relation / specifying one social order­
ing R for any n-tuple of individual orderings {/?,} defined over X.
R -/({*,}) (1)
Note that since the Bergson-Samuelson swf is an ordinal concept, it
can be viewed as a numerical representation of a social ordering R.
Hence, the Arrow SWF is a function the value of which is a Bergson-
Samuelson swf. Alternatively, the Arrow SWF is a method of ag­
gregating individual preferences into a social preference ordering.
Arrow proceeded to impose seemingly mild conditions that a reason­
able SWF could be expected to satisfy. These conditions are defined
below. In these definitions (and subsequently), N - {1,2,..., n} is the
society.
Condition U (Unrestricted Domain). The domain of the SWF in­
cludes all logically possible /i-tuples of individual orderings over X.
Condition D (Non-dictatorship). There is no individual i such that for
2Although Bergson introduced the concept of a social welfare function, it was really
Samuelson (1947) who investigated the uses to which such a function can be put. Not
surprisingly, this concept has come to be known as a Bergson-Samuelson social welfare
function.
Introduction 3
all preference n-tuples in the domain SWF /, for each ordered pair
x,yEX,xPiy-+xPy.
Condition P (Pareto). For all ordered pairs x,yEX, if for all in­
dividuals iEN9xPiy-+xPy.
Condition I (Independence of Irrelevant Alternatives). For all x,y
EX, for all /t-tuples {/?,} and {/?/}, if for all i EN, xRjy ++xRjy, then
xRy ++ xR!y where R -/({/?*}) andR' -/({/?/}).
Arrow proved the following remarkable result.
General Possibility Result. If X contains at least 3 distinct states, then
there is no SWF satisfying Conditions U, I, P, and D.
This basic result has given birth to the field of social choice theory.
This literature has explored the possibility of evading the nihilistic
conclusion of the General Possibility Result by relaxing the original
Arrow conditions. Unfortunately, the basic impossibility result is rem­
arkably robust to such modifications within the traditional Arrovian
framework.3
It has been suggested that the main reason for the plethora of
impossiblity results in the Arrovian framework is that the framework
fails to utilize a great deal of information. First, the traditional Ar­
rovian framework assumes that individual utilities are ordinal and
interpersonally non-comparable. Of course, it has been pointed out by
Sen (1970a) that allowing for cardinal but non-comparable utilities
makes no differences to the basic impossibility result. However, as I
will point out later, once the possibility of interpersonal comparability
is introduced, several interesting SWFs satisfy suitably modified ver­
sions of the original Arrow conditions.
Second, the Arrow framework involves welfarism, thereby ruling out
the use of non-utility information. Welfarism means that the social
welfare in state x is solely a function of the individual utilities in that
state. Hence, social welfare must be identical in social states x and y if
both result in the same individual utility distribution. In particular, the
process by which individuals derive their utility can have no impact on
social welfare.
^or excellent accounts of this literature, see Kelly (1978) and Sen (1986).