Welfare Economic Theory Research Articles

Morality and Economics

Economic theory rests on the principal axiom of egoism; that every action is driven by self interest, and is therefore seen as a moral‐free science. Morality, on the other hand, concerns subjective value judgement, usually in the interpersonal context of whether an action is right or wrong. Although the two are seemingly unrelated, welfare economic theory and its applications cannot proceed very far without the assistance of moral codes. This article discusses the origin and rationale behind the construction of moral codes, the moral codification of preferences and its associated problems.

Buying misery with federal land

Historians have documented the misery endured by settlers in the American west during the homesteading era, which began officially with the Homestead Act of 1862.1 The suffering was enormous. Economic historians have shown some reasons why the frontier was pushed back too rapidly under the policy of 'giving' land at zero (money) price to the first people willing and able to settle the land and to work it for five years. In essence, competition among potential claimants of the land was not in the form of bidding with dollars, but bidding in earlier settlement instead. The fact that early settlement could cause settlers to spend capital the 'grubstake' needed for survival plus the initial capital needed to set up a farm years before markets were available for farm products or for the purchase of farm inputs as well as years of hard labor in circumstances wasteful to them as a group and to society as well, is not at all inconsistent with economic theory. Given some simplifying assumptions, the economic theory of rent seeking2 suggests that premature settlement, as a means of competition among land claimants, may have destroyed an amount of settlers' wealth equivalent to all the potential value embodied in the unsettled territory beyond the frontier. However, more recent work on theories of rent seeking and welfare economics indicates that heterogeneity among potential settlers could have reduced substantially the wealth destruction inherent in the homesteading policy of land distribution. If a particular parcel of land were much more valuable to one potential settler than to all the rest, the competition of others might not bid up the cost (in the form of early settlement) sufficiently to destroy an amount of wealth equal to the full value perceived in the parcel of land. This paper will seek to show that in fact, a different form of heterogeneity differing expectations about furure returns to ownership of each parcel of land probably caused the homesteading policy to destroy not less, but more wealth than was commonly believed to exist in the form of claims to land available for homesteading. In addition, the policy hurt exactly the people pi-

Patents, Priority and Imitation or, the Economics of Races and Waiting Games

The literature on the economics of scientific and technological change presents a puzzle. The phenomenon assumes a central role when historians speculate on the unprecedented growth of economic well-being in western industrialised economies over the past one hundred and fifty years or so. And yet, modern resource allocation theory pretty much single-mindedly ignores the phenomenon.' Applied welfare economic theory, more specifically public finance, is today as crowded a field of research as ever before. But it rarely addresses a critical source of well-being: the production, dissemination and use of knowledge. Looking elsewhere, an impressive list of industrial case-studies shows uncompromisingly that research and development or R & D as it is most often referred to constitutes a central strategic weapon for firms in their quest for commercial profits, market share, or indeed plain survival. (See e.g. Enos, I962; Miller and Sawers, I970; Taylor and Silberston, I973; Mansfield et al. 1977; Constant, I980; Braun and Macdonald, i982.)2 Nevertheless, much of modern resource allocation theory seems to assume that neither 'ingenuity' (scientific and technological discoveries) nor 'abstention' (specifically, R & D investment) is subject to individual, corporate, or governmental choice and control. Technological change appears in modern resource allocation theory at least in its advanced-textbook guise much as does that most famous bark in literature: it does not. An occasional bout of schizophrenia can be healthy for a discipline. A persistent display cannot but be a symptom of something gravely wrong. This has not always been so. Classical economists were very much interested in the sources of the growth of economic well-being. But it was left to the last major figure of this school, Marx, to emphasise the role of technological change in capitalist development.3 Modern theorists of economic growth have for the

Applications of cost-benefit analysis to health care: Departures from welfare economic theory

In applying the principles of cost-benefit analysis to real world problems of resource allocation particular care must be taken to ensure that the welfare economic theory which underlies the cost-benefit technique is adhered to. Major problems arise where costs and benefits are used interchangeably to represent the good and bad attributes of a programme. Furthermore, in the presence of mutually exclusive projects, focussing attention upon the net benefits (or cost-benefit ratios) of individual projects as opposed to the net benefits of the use of budgeted resources can lead to biased estimates of the shadow price of projects and, consequently, errors in analysts' conclusions. As a result, economic appraisals of individual projects are not directly relevant for choosing between mutually exclusive projects of different sizes. Both types of problem are illustrated by reference to both simple examples and published economic appraisals of health care techniques. Integer programming is proposed and demonstrated as a method of selecting between mutually exclusive projects.

Nonuse Values in Benefit Cost Analysis

Benefit-cost analysis (BCA) is a pragmatic realization of the theory of welfare economics. Much of the research associated with BCA has sought to expand the types of benefits that can be measured in dollar terms. With this research there has been a progressive movement of goods and services from the set without measures (usually designated as intangibles in BCA terminology) to the set with. For example, the recreational services provided by projects associated with dams for hydroelectric power or flood control were regarded as intangible until the development of the travel cost model for estimating the demand for outdoor recreation sites.' One of the current frontiers in BCA research is associated with modeling and measuring nonuse benefits. In contrast to the past efforts with intangibles, research on this topic has remained controversial with few direct effects on the practice of applied welfare economics. There are two principal reasons for this outcome. First, there has not been an accepted set of definitions for nonuse benefits. And, second, applied studies with empirical estimates of nonuse benefits have, until recently, been non-existent. Clearly, these problems are related. A consistent set of definitions is a necessary prerequisite for empirical implementation. I will argue that consistent definitions for nonuse benefits have been elusive because the conceptual frameworks used in the literature to describe its primary components--option value and existence values-are not mutually consistent. In the process of demonstrating this result, I will describe the elements of a consistent framework for treating both use and nonuse benefits and apply it in explaining some of the problems with the available empirical estimates of nonuse benefits.

Equity effects in the estimation of leisure benefits

The use of cost-benefit analysis in leisure planning has been widespread, but it has invariably been restricted to the consideration of benefits accruing as the result of the allocative efficiency of leisure investments. Recourse to the theory of welfare economics indicates that this is not an exhaustive measure of benefits, since the effects of distributional equity are overlooked. This paper develops a model to encompass both efficiency and equity effects within a cost-benefit framework for leisure, before undertaking an illustrative application for the Derwent Reservoir sailing club in Northumberland, England. The results of this application indicate that benefits are significantly modified when equity, as well as efficiency effects are taken into account, in the measurement of leisure benefits.

PROPERTY ENTITLEMENTS AND PRICING POLICIES FOR A MATURING WATER ECONOMY

The Australian water economy is entering a mature phase characterised by inelastic supply of 'new' water and the need for expensive rehabilitation of aging projects. Thus, the policy focus will turn increasingly toward ways of restraining water demand and reallocating existing supplies. A prima facie case is made that the efficiency loss from current water pricing and allocation policy is significant. After considering the relevant welfare economics theory, the theory of administered prices and marketable property rights and some American proposals for reform, a system of transferable water entitlements is proposed and developed.

The Search for Equity and Efficiency in the Pricing of a Public Service: Urban Water

The operationalization of a marginal cost pricing scheme must account for conventions consonant with basic welfare economic theory. The welfare gains associated with adopting alternative tariffs must outweigh the costs of implementation. An in-depth analysis of one utility in suburban Washington, D.C., shows that significant welfare gains would accrue with the implementation of marginal cost pricing.

Urban Planning and Social Welfare

The rationale which welfare economics provides for urban planning activity seems to be fairly well established, and welfare economic theory can thus be seen as a valuable basis for a theory of planning. However, two major issues concerning the impact of planning activity on social welfare still need to be considered even if this basis is accepted. The first of these is the question of distribution. If society considers some distributions of welfare superior to others and if, as welfare theory demonstrates, each resource (re)allocation has different distributions associated with it, then the degree to which planning activity in affecting the allocation of resources actually leads to an increase in social welfare depends on the distributional effects of that activity and the criteria by which they are judged. The second issue is that of the legitimacy of the sort of intervention into individuals' activities which planning represents, and the degree to which intervention, even if justified theoretically, is in practice welfare-maximizing. It is concluded that although welfare economic analysis does provide many insights into the implications of urban planning for social welfare, the issues of distribution and intervention which are crucial to any consideration of the welfare effects of planning can be resolved only by reference to values the justification for which lie outside traditional welfare economic theory itself.

AN HISTORICAL SURVEY OF THE EARLY DEBATE ON CONSUMER'S SURPLUS THEORY

Consumer's surplus now plays an important role in public sector investment analysis (notably social cost‐benefit analysis) and is central to much of modern welfare economic theory. Despite this it is still a topic of considerable controversy and debate; indeed few concepts in the recent history of economic thought have aroused such a diversity of opinion. It must be almost unique, for example, for two Nobel laureates in the same discipline to take diametrically opposed positions over the importance of a basic method of measurement in their own subject. We find, however, Sir John Hicks arguing that ‘if economists are to play their part in shaping the canons of economic policy fit for a new age, they will have to build on the foundations of consumer's surplus’ whilst on the contrary Paul Samuelson dismisses the concept as being of ‘historical and doctrinal interest with a limited amount of appeal as a purely mathematical puzzle’.

Municipal Ownership of Electrical Utilities and the Fiscal Problems of the Cities

The author begins with a history of recent interest in municipally- owned electric utilities (MUNI's) and then argues that neither welfare economic theory nor empirical econometric work provide much of a case against MUNI's. After identifying three views on the municipal ownership issue, two interpre tations of cities' fiscal ills are distinguished: one which neglects and one which suggests MUNI's as remedies. Some new empirical evidence is presented on (1) the proportion, and change in proportion, of general revenues MUNI's generate for their cities and (2) the comparative Moody's bond ratings of cities which do and don't own MUNI's. The author closes with some ideas for further research and the suggestion that discussions of local fiscal policy options which neglect MUNI's may be ideological defenses of the owning classes.

Remarks on the Theory of Collective Choice

Ever since the so-called paradox of voting was generalized by Arrow (1963) to every democratic method of collective decision-making, a vast literature has appeared (a) trying to circumvent Arrow's difficulty by weakening some of his conditions (Bordes, 1976; Hansson, 1973; Plott, 1973; Sen, 1969); (b) proposing some other paradoxes in the theory of collective choice (Batra and Pattanaik, 1972; Hansson, 1969; Schwartz, 1970; Sen, 1970a) and (c) casting doubts about the relevance of Arrow's theorem to the theory of Paretian welfare economics (Bergson, 1966; Little, 1952; Samuelson, 1967, 1977). The purpose of this paper is to make some remarks on these recent developments in the theory of collective choice. The first part of the paper deals with the question of how much one needs to weaken Arrow's collective rationality condition in order to avoid his impossibility result. As is well known, Arrow (1963) imposed the collective rationality condition that the society can arrange all conceivable alternatives in order of preference and that, if some available set of alternatives is specified, the society must choose therefrom the best alternative with respect to that preference ordering. We will consider two conditions of consistent choice which are weaker than that of Arrow. The first condition requires that, if an alternative x is chosen over another alternative y in binary choice, y should never be chosen from any set of alternatives that contain x; while the second condition requires that, if x is chosen over y in binary choice, there exists no choice situation in which y is chosen and x is available but rejected. (In the second case y can be chosen if x is also chosen, while in the first case y cannot be chosen anyway.) There seems to be a gulf that separates possibility from impossibility in between these two seemingly similar consistency conditions. It will be shown that the first consistency requirement is incomnpatible with essentially Arrovian conditions on the collective choice rule, while the second consistency condition is compatible with the same conditions. Although the difference between these consistency requirements is very subtle, the implication thereof in the context of impossibility result is therefore dramatically different. Lest we should be too satisfied, we must hasten to add that no collective choice rule satisfying our second consistency requirement can be free from the paradox of Paretian liberal (Sen, 1970a; Batra and Pattanaik, 1972). The Arrow-Sen theory is then contrasted with the Bergson-Samuelson one. In view of doing this, it is convenient to remember that Arrow's incompatible conditions on collective choice rule can be classified into two categories. The first category consists of statements that apply to any fixed profile of individual preference relations, while the second category refers to the responsiveness of the collective choice to the variations in profiles. (The first category embraces the condition of collective rationality and the Pareto rule, while the second category consists of the independence of irrelevant alternatives

Analyzing the Marginal Cost of Water Supply

The operationalization of a marginal cost pricing scheme must account for conventions consonant with basic welfare economic theory. The welfare gains associated with adopting alternative tariffs must outweigh the costs of implementation. An in-depth ...

Risk, Uncertainty and Moral Hazard: Comment

Being interested in the application of welfare economics to insurance, I have been intrigued by the attention given in recent issues of this Journal to this subject. The primary purpose of this comment is to make some observations about part two of Herbert G. Grubel's fine piece, Risk, Uncertainty and Hazard.1 The heading Professor Grubel uses for part two is Moral Hazard and Social Insurance. The issue for discussion in my comment has to do with welfare economics and compulsory medical care insurance. The specific question I would like to treat is this: Does any situation necessarily exist in regard to which welfare economic theory would indicate that introduction of a compulsory medical care insurance plan would necessarily lead to an increase in total economic welfare? Since part two of Professor Grubel's article builds on work done by others, a brief review of this other work is necessary to remind ourselves of the context in which his article and my comment are offered.

General Multistage Marginal Cost Dynamic Programing Model for the Optimization of a Class of Investment‐Pricing Decisions

A general method is developed for finding an optimal solution to the dynamic investment‐pricing problem of a publicly owned or regulated monopolistic enterprise with a technology of production exhibiting economies of scale given a market demand for the output of the enterprise that is sensitive to price. Previous authors have dealt successfully with the same capital investment problem under the assumption of completely inelastic demand; price has thereby been eliminated as a rationing device. The major significance of the general model developed here is that it combines the theory of welfare economics and the dynamic programing technique to solve the joint investment‐pricing problem under a particular, but not too restrictive, set of structural and procedural assumptions.

Benefit-Cost Analysis: Its Relevance to Public Investment Decisions

What is the problem? 208. — Have benefits been overestimated? 211. — How did we get to where we are? 212. — What changes in welfare economics theory are needed? 213. — What is the evidence that trade-offs can be determined? 218. —The lesson, 225.

A Welfare Criterion

* author is indebted to E. Philip Howrey of Princeton University for suggesting many improvements. Any remaining shortcomings are the responsibility of the author. 1 For a review of the extensive literature on the new welfare economics and the Pareto optimum, cf., for example W. J. Baumol, Welfare Economics and the Theory of the State (Cambridge, Mass., 1952); I. M. D. Little, A Critique of Welfare Economics (Oxford, 1957); M. W. Reder, Studies in the Theory of Welfare Economics (New York, 1947); T. Scitovsky, The State of Welfare Economics, American Economic Review, 41 (1951), pp. 303-15. 2 J. R. Hicks, The Valuation of Social Income, Economica, 7 (1940), pp. 163-72; The Valuation of Social Income-A comment on Professor Kuznets Reflections, Economica, 15 (1948), pp. 163-72; S. Kuznets, On the Valuation of Social Income-Reflections on Professor Hicks' Article, Economica, 15 (February and May, 1948), pp. 1-16, 116-31; I. M. D. Little, op. cit.; P. A. Samuelson, Evaluation of Real National Income, Oxford Economic Papers, 2 (1950), pp. 1-40. sequently, the scope of the welfare criterion is increased.

A Critique of Welfare Economics.

A Critique of Welfare Economics was first published in 1950. It was concerned with the exposition, criticism, and appreciation of the theory of economic welfare as it had been developed to that date. It was an attempt to clarify what was meant by 'welfare'; to distinguish measurable, verifiable elements of the theory from subjective normative judgements about policies for improving economic well-being; and to establish criteria for determining whether one configuration of the economic system is better or worse than another. Little showed that the welfare theory of the time could be based directly on individual market choices, and that resort to traditional utilitarian concepts was not essential. A Critique of Welfare Economics is now reissued at the same time as Ethics, Economics, and Politics -- Little's latest book which explores the overlap between the three disciplines, and discusses the need for political decisions in economic matters, and the principles guiding them. He has added a new retrospective preface to Critique in which he assesses the contribution the book made in the light of subsequent literature in the area.

A Re-Appraisal of the Principles of Resource Allocation

A rejection of the theories of welfare economics carries with it the judgment that there is at present no rule or method by which we may judge of the relative efficiency of alternative forms of economic organization; indeed, that any conceivable set of production plans or any conceivable set of prices, no matter how arbitrary, are-in our present state of knowledgeto be considered as good as any others. Few economists, even among those who are wont to treat welfare economics with extreme scepticism, will go as far as this to avoid courting the subject while economists of the liberal school who talk of a presumption in favour of the market mechanisms must, if they are to rationalize this presumption, invoke some theory of welfare. Put at its bluntest then it is in pursuit of an answer to the question, by what lights are we to distinguish between a good allocation and a chaotic one, that we are led willy-nilly into the domain of welfare economics. Notwithstanding the logic of this conclusion a great deal continues to be written concerning economic efficiency which deliberately eschews the language of welfare economics, relying instead on apparently more acceptable criteria-for instance, the ' common sense' rule that total receipts should be able to cover total costs supplemented, perhaps, by rules about marginal equalities. For the abiding impression seems to be that by confining oneself to the traditional rules governing the allocation of resources one somehow circumvents the tenuous concepts and fine paradoxes of welfare economics. After all, there are critiques and counter-critiques of welfare economics and in the process a great deal of smoke and subtlety is generated. But the principles of resource allocation are of more solid stuff. They are ever with us and in continual application. This view, however, does not bear close examination. A by-product of this paper will be the demonstration that certain familiar welfare criteria and the so-called optimum conditions of resource allocation are raised on the same foundation: they stand or fall together. In fact the relationship is so close it is almost inevitable that allocative criteria

Investment Criteria for Economic Development and the Theory of Intertemporal Welfare Economics

Introduction, 56.- I. The ideal criterion under perfect competition, 57. II. Capital rationing: the SMP criterion in a closed economy, 59; correcting market prices to reflect social values, 60; the interest rate in the SMP criterion, 63. - III. Modifying the rate of capital accumulation: the MGC criterion, 65. IV. The interest rate in development planning, 74. - V. Some extensions of the analysis, 79; the optimal interest rate for the SMP criterion, 79; multiple rationing: investment criteria in the open economy, 81. - VI. Some limitations of the analysis, 83; population still an exogenous variable, 83; income distribution assumed satisfactory, 83. - VII. Concluding comments, 84. The applicability of orthodox efficiency criteria for the selection of investment projects in underdeveloped countries has been challenged on a number of grounds in recent years. Much of the literature supporting the doctrine of balanced growth argues that the static optimum criteria of the free market economy fail to maximize economic growth and must be seriously modified in order to assure proper exploitation of external economies.' Professors Galenson and Leibenstein2 have now carried these criticisms to their extreme conclusion by arguing that the orthodox criteria will systematically interfere with economic growth and that criteria of an altogether different nature should be used. In the present article I seek to indicate the kind of criteria that are needed for project selection, given some of the specific market imperfections found in underdeveloped countries, and particularly assuming that the capital market performs its functions poorly or not at all. The criteria developed are assumed to be applied by a development planning authority which has some control over the choice of projects to be undertaken.