Transcript Welfare economics

Chapter 15
Welfare economics
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
9th Edition, McGraw-Hill, 2008
PowerPoint presentation by Alex Tackie and Damian Ward
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Welfare economics
• The branch of economics dealing with
normative issues.
• Its purpose is not to describe how the
economy works
• but to assess how well it works.
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Equity and efficiency
• Horizontal equity
– the identical treatment of identical
people
• Vertical equity
– the different treatment of different
people in order to reduce the
consequences of their innate differences
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Pareto efficiency
• An allocation is Pareto-efficient for a
given set of consumer tastes, resources
and technology, if it is impossible to
move to another allocation which would
make some people better off and
nobody worse off.
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Perfect competition and Pareto
efficiency
• If every market in the economy is a
perfectly competitive free market, the
resulting equilibrium throughout the
economy will be Pareto-efficient.
• As expressed in Adam Smith’s notion of
the Invisible Hand.
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Competitive equilibrium and
Pareto-efficiency
SS
D
P1*
D
• At any output such as Q1*,
the last film must yield
consumers P1* extra utility.
• The supply curve for the
competitive film industry
(SS) is the marginal cost of
films.
• Away from P1*, Q1*, there
is a divergence between the
marginal cost and the
marginal benefit derived by
consumers
• so a move to that position
makes society better off.
Q 1*
Quantity of films
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Market failure
• … occurs when equilibrium in free
•
•
•
•
unregulated markets will fail to achieve
an efficient allocation.
Imperfect competition
Social priorities (e.g. equity)
Externalities
Other missing markets
– future goods, risk, information.
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Externalities
• An externality arises whenever an
individual’s production or consumption
decision directly affects the production or
consumption of others …
• other than through market prices
– e.g. a chemical firm discharges waste into a
lake & ruins the fishing for anglers
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Externalities
• Negative Externality: Smoking, Pollution.
• Positive Externality: Education
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A production externality
Suppose DD represents
the demand curve for a
product (which we may
interpret as marginal
social benefit).
D
P
MPC
D
Q
Quantity
MPC is the marginal
private cost incurred by
the firm in producing
the good (assumed
constant for simplicity).
The market clears where
MPC = DD at price P and
quantity Q.
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A production externality
MSC
If the firm causes pollution,
it imposes costs on society,
presented by marginal
social costs (MSC).
So the social optimum is
where DD(MSB)=MSC at Q*.
Q* Q
The overall welfare
MPC loss to society from
the market failure is
DD
given by the excess
(MSB) of MSC over MPC
between Q* and Q.
Quantity
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A consumption externality
E.g. neighbours may benefit from a well-kept garden.
Price
MPC,
MSC
MSB
DD(MPB)
Q
Q'
As a consequence of a
consumption externality
MSB>MPB, and the
free market equilibrium
provides the quantity Q.
As compared with the
social optimum at Q',
where MSB = MSC.
The brown area shows the
welfare loss.
Quantity
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Greenhouse gases
Emission of greenhouse gases
120
100
80
Index (1990 =
60
100)
40
1990
1995
2012
20
0
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Climate Change
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Kyoto Protocol
• Began 1997
• By 2006 169 countries had signed,
(not including the US)
• Turkey signed in 2009.
• BY 2012 emissions will be 5% lower
than in 1990
• Various schemes in place including
carbon trading
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Kyoto Protocol
• Will End in 2012
• International Conferences for a new
protocol
• Copenhag 2009, Durban 2011
climate meetings
• Durban 2011: Countries will form
their plans until 2015 and apply it by
2020.
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Is it worth it?
• Should China cut back today, to
make the future better?
• Stern review suggests that cuts in
carbon emissions will only cost 1% of
GDP per annum.
• If we do not take precautions, then
the cost of disasters due to the
climate change are predicted to cost
us 20% of the GDP.
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