Welfare Economics

“The greatest meliorator of the world is selfish, huckstering trade.” (R.W. Emerson, Work and Days)

Welfare Economics is a normative branch of economics that is concerned with the way economic activity ought to be arranged so as to maximize economic welfare. The hallmark of welfare economics is that policies are assessed exclusively in terms of their effects on the well-being of individuals. Accordingly, whatever is relevant to individuals well-being is relevant under welfare economics, and whatever is unrelated to individuals well-being is excluded from consideration under welfare economics. Economists often use the term utility to refer to the well-being of an individual, and, when there is uncertainty about outcomes, economists use an ex ante measurement of well-being, so-called expected  utility. Welfare economics employs value judgement s about what ought to be produced, how production should be organized, the way income and wealth ought to be distributed, both now and in the future. Unfortunately, each individual in a community has a unique set of value judgements, which are dependent upon his or her attitudes, religion, philosophy and politics, and the economist has difficulty in aggregating these value judgement s in advising policy makers about decisions that affect the allocation of resources (which involves making interpersonal comparisons of utility).

The branch of economics called welfare economics is an outgrowth of the fundamental debate that can be traced back to Adam Smith, if not before. It is the economic theory of measuring and promoting social welfare. In The Wealth of Nations, Book IV, Smith wrote: “Every individual necessarily labors to render the annual revenue of the society as great as he can.… Read the rest

The Role of Government in Environmental Protection

The final controlling authority in most of the issues related to environment is the government itself. For example, most of the thermal power plants are owned by the government and also only the government can build dams, roads, railways, etc. Industrial or any other related activity cannot start without the approval of the government. Therefore, the government has to apply various checks and controls so that the environment is managed properly.

How can the government establish incentives that would lead industries to choose the efficient amount of pollution control in their own best interest, even if they do not face all the social costs of residual emissions?

1. Direct Regulation

Direct regulation of polluting activity (i.e., setting a legal limit for pollution) frequently comes to mind. The government could, for example, simply limit the industry’s pollution to R units by decree. Direct regulation of this sort was popular in the United States shortly after the setting up of Environmental Protection Agency, a government organization tasked to regulate any practice that may have an adverse effect on the environment. Created in 1970, the EPA became the US government’s answer to increasing qualms about the wanton disregard of some industries and their unsafe practices that pose hazards to human health and the environment in general.  Aside from safeguarding human and environmental health, the EPA is also empowered to craft and enforce regulations under existing environmental laws. It is also responsible for researching various methods to protect the environment.  Since its creation, the EPA took the lead in implementing changes to make the United States a better place to live in.… Read the rest

The Economists View of Environmental Pollution

Why do people use resources like the environment? This is because, pollution is a byproduct of activities that add to their welfare. These activities bring economic gain to producers and utility gain to consumers. We do not pollute the planet just for fun; we do it as part of activities that improve our welfare. The economists view of environmental pollution is that pollution creates another trade-off of cost and benefit that must be weighed on a case by case basis.

Many of our streams and lakes have historically served as depositories of chemical waste generated by industrial plants and mines. Some are cleaner now, but many still suffer damage form earlier discharges of chemicals, like PCBs whose “half-lives” are measured in hundreds of years. Many pesticides, fertilizers, and detergents used by farms and homes find their way into our lakes and waterways, where they have damaged commercial and recreational fishing. Automobiles are primary source of many air pollutants. The residue of their emission can foul both the air that we breathe and the land located close to the road that we drive on. Factories generate particles of various kinds, often through the combustion of fossil fuels; these pollute the air and fall onto the ground-both near and far. Some of our pollution has even been shown to cause damage on a global scale. The production and emission of chlorofluorocarbons has damaged the ozone layer and exposed much of the planet to increased ultraviolet (UV-B) radiation from the sun; the emission of carbon dioxide and other greenhouse gases has begun to warm the planet at rates that many find alarming.… Read the rest

Poverty Trap

Poverty trap is a situation where an unemployed person receiving social security benefits not encouraged to seek work because his or her after‐tax earnings potential in work is less than the benefits currently obtained by not working. The poverty trap occurs due to benefits such as income support, housing benefit, single parent allowance and family tax credit. Given that social security benefits represent the ‘bottom line’ (that is, the provision of some socially and politically ‘acceptable’ minimum standard of living), the problem is how to reconcile this with the ‘work ethic’.

For example, consider the case of a low-skilled person in the UK. He is unable to get a high-paid job because he doesn’t have the right skills, training or experience. He has two options. First one is to get a low-paid job or second option is to claim unemployment benefits. If he gets a low paid job he will have to pay taxes and national insurance so he decides he is actually financially better-off just claiming benefits for being unemployed. As time goes by he carries on claiming benefits and continues to lose his ability and confidence in himself. This makes it more difficult for him to get a decent-wage job and more appealing to continue living on benefits. We can say that he is in the poverty trap.

One suggested way to release people from poverty trap is for government to provide employers with employment subsidies that allow them to pay wages higher than the minimum level of social security, even though the marginal revenue product of the work undertaken does not warrant it.… Read the rest

The Edgeworth Box

In 1881, Francis Y. Edgeworth came up with a way of representing, using the same axis, indifference curves and the corresponding contract curve in his book “Mathematical Psychics: an Essay on the Application of Mathematics to the Moral Sciences”. It was Vilfredo Pareto, in his book “Manual of Political Economy”, 1906, who developed Edgeworth’s ideas into a more understandable and simpler diagram, which today we call the Edgeworth box.

Edgeworth box a conceptual device for analyzing possible trading relationships between two individuals or countries, using indifference curves. It is constructed by taking the indifference map of one individual (B) for two goods (X and Y) and inverting it to face the indifference map of second individual (A) for the same two goods. Thus, Edgeworth box is a traditional visualization of the benefits potentially available from international trade.

Individual A’s preferences are depicted the three indifference curves A1, A2 and corresponding to higher levels of satisfaction as we move outward from origin OA. Individual B’s preferences are depicted by the three indifference curves B2 and B3, corresponding to higher levels satisfaction as we move outward from origin OB. Both consumers’ preferences between the reflected in the slopes of their indifference curves, with the slope of a curve at any point reflecting the Marginal Rate of Substitution of X for Y. Only where individual A’s indifference curves are tangential to individual B’s indifference curves (points E, F and G) will A’s marginal rate of substitution of product X for product Y be the same as B’s marginal rate of substitution of X for Y, so that their relative valuations of the two products are the same.… Read the rest

Importance of Capital Controls in Economic Policy

Globalization of capital investment and finance has surfaced for a long period of time in the world of global financial market. Capital flow liberalization has brought up the importance of capital controls for some countries to achieve their economic growth.

The Description of Capital Controls

Since the failure of Bretton Woods system in 1971, the international capital movements within developed and developing countries become unstable and for some countries the capital flows need to be controlled. Capital controls are restrictions to regulate the movement of capitals which are flowing in or out of the country. Capital flows may be in forms of bank loans, portfolio investment and foreign direct investment. The controls of short terms portfolio investment and bank loans are quite necessary since they are quite risky because of the roll-over risks. For long term credits and FDI are less risky if they are politically guaranteed.

Looking back to the history of capital controls there were two different perspectives. The first was John Maynard Keynes who was the pioneer of the capital controls regime. Keynes was supported by other known economists such as James Tobin, Dani Rodrik and Joseph Stiglitz. The main ideas behind their view are that financiers are really powerful to pursue profits in every part of the world and ignoring other factor such as labor. Keynesian view assumes that a fragile financial system is caused by the free movement of capital as volatile capital flows and it will lead to destructive of important asset prices such as exchange rate, equities and real estate.… Read the rest