Basics of Welfare Economics

Economics deals with how people distribute scarce resources. This is true for a family, a small business and an entire nation. Economic theory can help to understand why some countries succeed while others fail miserably and it points the way to empowering changes that could improve the lives of all people in society.

The Basics of Welfare Economics are what economists explore when they want to know more about how people share their resources with one another and make decisions about what outcomes society should strive for.

The concept of Welfare Economics is straightforward. At its core, the idea is to provide information about how best to organize economic activity in order to maximize a society's welfare. In order for economists to figure out what the most effective way is for people to organize their resources, they need a set of core principles known as the Basic Principles of Welfare Economics. This article will go over what those principles are and why they're important.

The Basic Principles of Welfare Economics include four distinct ideas. These are: Allocation efficiency, Cost-benefit analysis, Efficiency under conditions of scarcity and  Pareto efficiency . Each will be discussed in detail in this article.

Allocation efficiency. In order for any group of people to allocate their resources, they must have a way to gather and process information about those resources. The allocation efficiency principle resolves how this information should be gathered and processed. Basically, it states that the best way for a society to allocate its scarce resources is via market mechanisms. This includes offering goods and services for sale by private parties at prices decided upon by the law of supply and demand as well as allowing individuals to decide on a voluntary basis how best to spend their income after paying taxes (taxes being another form of market-based allocation). These mechanisms are efficient. They provide the information that is needed to arrive at the best possible decisions about what goods and services should be produced, how much of any given good or service should be produced, and how best to communicate that information to everyone in society.

Economists refer to the most efficient allocation of resources as an economically competitive equilibrium. This means that an economically competitive equilibrium is one where there are no more ways for individuals in society to make themselves better off without making others worse off. At the same time, this economic competition results in a maximum total benefit for society as a whole. That is, the economic competition leads to the generation of the greatest total benefit for each member of society than any other state of affairs.

Cost-benefit analysis. Cost-benefit analysis is another important principle that is part of the Basic Principles of Welfare Economics. It says that a society should never undertake an economic activity unless it results in a positive net benefit . That means that the costs have to be less than or equal to the benefits. This is true whether it's putting a new highway in, creating a national infrastructure or funding research and development for new technology.

Economists use cost-benefit analysis extensively when discussing policy proposals because it helps them understand whether or not creating any given policy will result in people being better off. In particular, the advocates of neoliberalism, free-market capitalism, and other types of market fundamentalism rely on cost-benefit analysis to argue that the way that economies are structured is the best way to go.

The reasons why cost- benefit analysis should be used in economic policy debates have already been discussed in previous articles on this site. In a nutshell, cost-benefit analysis helps economists and policymakers understand what makes an economic activity sound in terms of its general effects on society as a whole and whether or not any given economic activity is likely to lead to benefits for society as a whole.

 Efficiency under conditions of scarcity. The final basic principle that's part of the Basic Principles of Welfare Economics is Efficiency under conditions of scarcity . Simply put, this principle says that a market-based allocation of resources is the most efficient way to organize society when there are no alternatives. The reason why it is the most efficient under these circumstances is because a market-based allocation allows any and all individuals in society to maximize their gains from participating in that economic activity without having to undermine the welfare of some other people.

To understand what this principle means for an economic topic such as minimum wage laws or trade union rights, imagine there is a farmer who makes food for the community using their farm animals. The farmer wants to determine if it would be more beneficial for them if they raise more animals or if they sell their surplus animals at market prices (the price determined by supply and demand). To figure this out, they'll have to compare the cost of raising more animals to the income that they will receive from selling them on the market.

If the farmer is considering whether or not to raise more animals, they must take into account how much it will cost them to do so. This includes how much money they need to spend on feed, what it will cost them in terms of time and energy and even how much money it will cost them if an animal gets injured during market transport.

Efficiency under conditions of scarcity says that in order for the farm owner to figure out whether or not they should increase their production of food, all relevant costs and benefits should be included in a cost-benefit analysis. The value of one life is not taken into account. The value of one's leisure time is not taken into account. The cost to the farm owner of carrying animals to market and the time spent transporting them are not taken into account in this analysis.

Now imagine that the community decides they would rather have their farmers raise more animals than they would sell their surplus animals at market prices. What happens now? In this case, the community gets more food for less money than before. This means that the community's net benefit from raising more animals has increased and that it has also become less expensive for them to do so.

The community members are not better off because the costs associated with raising more animals have also gone up. At the same time, the community has less money to spend on other things. This means that their net benefit from raising more animals has decreased and that it has also become more expensive for them to do so.

To put it another way: if not for the fact that the community members perceive economic activity as organized through an economic market and are committed to this market's organization of society, then in a situation of scarcity, raising animals for food would not be considered a desirable way to allocate scarce resources. Using the market to allocate scarce resources is efficient only if the market-based allocation is the best way for society to choose.

To see how this principle applies in practice, imagine there are two small towns that are trying to decide how they should deal with a new highway created by the government (the government plans on using tax dollars from both towns). The first town votes to have their town pay more taxes than the other town so that they can have a new highway that runs through their city. They reason that having better access will mean more business and growth for their community.

Conclusion

A basic principle of welfare economics is that markets are the best way to organize economic activity, even during periods of scarce resources. However, before the market can be considered the best way to allocate scarce resources, all costs and benefits of economic activity are taken into account and each community member must decide for themselves whether or not a market-based allocation is desirable.

This article has discussed three key principles that should guide economists and policymakers when discussing economic policy issues including minimum wage laws and trade union rights. Readers' comments are welcome on this or any other topic related to economic principles or public policy issues. You can contact me at shrewd.economics@gmail.com .