Microeconomic Policy Evaluation - Assignment Example

Name Class Unit (a) ‘Social welfare functions embody a normative conception of the relative importance of equity and efficiency’. With the aid of diagrams, illustrate and explain this proposition. Social Welfare Function (SWF) is a summary of the society attitude based on the varying distributions of incomes and welfare (Dolgoff & Feldstein, 1999). With social welfare function, the concept of equity and efficiency are very vital. When looking at social welfare, the notion is attributed to the whole society. In a democratic society, the economic policy is expected to bring neutrality among individuals. Thus, social welfare is expected to be symmetrical among individuals (Popple & Leighninger, 2001). It is also assumed that the welfare of an individual in an economy increases as their income level increases. Equity Efficiency Fig. 1, Equity and efficiency From the economist point of view, optimal allocation of resources is determined by being efficient and equitable. Resource allocation can only be efficient if by allocating it, it is impossible to make one member of society well off without making some other members of the society worse off. Efficiency is based on the Pareto optimality. In social welfare, efficiency is necessary but it is not considered sufficient (Friedman, 2002). The number of efficient economic allocation is infinite and are only distinguished through equitable. The distribution of goods and services in a society must be fair thus equitable. The concept is normative and does not have universal definition. This is due to fact that what is equitable to one member may not be equitable to the other (Lang, 2010). It is also important to note that equitable distribution does not imply equal distribution. Equity and efficiency defines are the two conditions that defines social welfare. The two conditions thus are used to explain maximisation of society welfare (Friedman, 2002). If two resource allocations in an economy are efficient, they have same degree of efficiency. The best allocation of resources is supposed to give the maximisation of social welfare (Blau & Abramovitz, 2004). Efficiency in an economy requires efficiency in production, efficiency in exchange and efficiency in the interface between production and exchange. In microeconomic, equity and efficiency plays a major role. In an economy, economic efficiency refers to maximisation of the money metrics. Income distribution in a society affects their equity and efficiency. Through use of various assumptions, it can be proved that economy reaches equilibrium at Pareto optimal point (Kaplow, Shavell & National Bureau of Economic Research, 1999). At this point, a movement in economy makes someone worse off. When the economy is not at the Pareto point, it is possible to make movements which make one person better off without making anyone worse off. This is defined as Pareto movement and is one of the most fundamental judgements in welfare economics (Friedman, 2002). Through Pareto movement, the definition of economic efficiency is achieved. Ut welfare a m b Mu C U0 Fig.2 Maximum Social Welfare Function The utility possibility curve acts as the constraint. Mu is the function for Ulitarian. Efficiency in production is attained when it is impossible to enhance production of one good without decreasing production of the other. Efficiency in consumption is achieved if allocation of resources is such that it is impossible to increase one member utility without reducing other member utility. It is vital to note that overall efficiency is necessary but is not a sufficient condition in maximising social welfare (Friedman, 2002). Social welfare is seen as a function of utility of its members. According to the old welfare economics, social welfare is considered as a cardinal notion. The new welfare economics looks at social welfare as an ordinal notion (Tripp, Payne & Diodorus, 2009). Society is not always in the efficiency equity frontier. Hence, it is possible to increase both equity and efficiency at the same time. According to the second theorem of welfare economics, a society is able to attain maximum outcome through free trade and suitable redistribution of its resources. This leads to a situation where the society is forced to trade between efficiency and equity (Friedman, 2002). To resolve the trade off is very hard as compared to coming up with efficiency maximising policies. SWF involves the equity efficiency trade off through decision making. When there is loss of efficiency, all in the society becomes worse off. This can be compensated through redistribution of resources. According to the utilitarian social welfare function, all individual utilities are given same function. The function defines the society as utility rich or utility poor (Cnaan, Dichter, & Draine, 2008). The society welfare can only be improved by maximising the utility of the worse off person based on Rawlsian social welfare. In a society, efficiency and equity contradicts. This occurs when more efficiency leads to less equity and vice versa. This leads to a trade off between the two objectives when they contradict. This view is opposed by Rawlsian approach which asserts that society welfare is able to improve when the lowest position is able to improve (Friedman, 2002). The increase of utility of one individual can be used to increase the utility of the other. U2 B W2 A W1 W0 U1 Fig. 3. Rawlsian SWF. Rawlsian SWF Claims that distributive justice is biased depending on our status in life. Rich do not favour redistribution policies while poor will always do. W1- moving from point A, which is equal utility to point B makes one better off without affecting the welfare of another individual. At this point social welfare is not affected. The theory is an opposite extreme of utilitarianism. Through use of social welfare function, it is possible to balance efficiency and equity. SWF also acts as a function of the per capita income and income equality in a given society. The Pareto optimally is seen to reject ethics due to fact that it does not look at individuals as having equal capacity in enjoying a share of income (Dolgoff & Feldstein, 1999). Despite this, Pareto efficiency criteria are seen as one of the most desirable social welfare function. According to Pareto principle, an increase in one person income in a society holding other things constant leads to an increase in social welfare (Schneider, 2006). This is due to fact that increases in one person income increases total society income and changes inequality. Social welfare function is thus made of two arguments which are efficiency and equity. There is Sen-type SWF which have its main emphasis on efficiency. According to Sen-type SWF, when there is increase in allocation to the rich in extreme case, there is an increase in social welfare (Schneider, 2006). A D AS Pe B E Pr C AD Qe Qr Fig. 4, First fundamental theorem and social welfare Point Q is the competitive equilibrium. Any quantity other than Q, minimises social efficiency. At Pr, CS=A+B, PS=C At Pe, CS=A+D PS=C+B+E Loss of surplus=D+E (b) ‘As tools of real-world policy analysis, social welfare functions have been subjected to severe criticism’. Discuss with extensive reference to the literature on theoretical welfare economics, including Arrow's famous Impossibility Theorem Social welfare function has been subjected to a lot of criticism. There are three main argumentations: Arrow’s general impossibility theorem, Bauchanan’s criticism and public choice criticism. The three criticisms are founded differently and have varying implications. Arrow general possibility theorem The Arrow general impossibility theorem is based on axioms. The axioms are; unanimity, non-dictatorship, transitivity, range and independence of irrelevant alternatives. According to unanimity, an individual preference is not supposed to be opposed by preference of another individual. The preference is preserved in social ordering. Non-dictatorship implies that there is no single individual who enjoys a position such that when they make a preference between two alternatives the rest of individuals choose opposite preference. The individual preference is preserved in the social ordering (Maskin, Sen & Arrow, 2014). Transitivity implies that social welfare function presents a consistent ordering according to feasible alternatives. Range is based on unrestricted domain where there is no universal alternative. According to the independence of irrelevant alternatives, making a social choice among alternatives is only based on individual orderings over the alternatives. The SWF does not support these conditions according to the Arrow’s general impossibility theory. According to the theorem, there is no single way in which one can arrive at a social choice procedure to determine what to choose. Arrow’s theorem is based on the axomic method (Maskin, Sen & Arrow, 2014). This is through use of set of reasonable axioms and determining their implications. According to arrow’s theorem, it is impossible to construct a social choice method that can satisfy all his five axioms. Even through removing one or more axioms from his theory cannot lead to conclusive results (Maskin, Sen & Arrow, 2014). Arrow was considering a SWF which generates outcomes according to the people’s preference. Arrow theorem imposes constraints on SWF. Through this, he is able to show that SWF lacks logical space which it can satisfy the proposed criteria. He gives conditions which sets the boundaries of what is possible. Arrow asserts that formation of SWF should not be dictatorial. This has been supported by various literatures that consider that designers of social choices have to ensure they are not dictatorial. According to Arrow, social choice in any environment is based on individual preferences in any environment. Arrow’s theorem embodies that in an ordinal setting, a fair society is able to maximise utility (Maskin, Sen & Arrow, 2014). In this case, fairness and wellbeing are able to stand together. According to Arrow’s theorem, the type of utility that is being considered has a great effect on the feasibility of SWF. Using ordinal utility, it is hard to come up with an aggregate level of society wellbeing which trades off between wellbeing of individuals. This is due to fact that there is no sufficient information based on ordinal utility that can be used to come up with the comparison (Patty & Penn, 2014). The available information that is used to aggregate people is based on the absolute measures. There has been a lot of criticism based on the ordinal utility assumptions. For example, Rawls propose the framework of human rights and equality that is used by modern legal systems to be the starting point in distribution discussions. The main claim is that egalitarian solution is supposed to be used only when it is capable of improving the framework to every citizen. This gives a platform to look at fairness and value in a deep way than one offered by ulitarian measures (Friedman, 2002). According to the argument, it is better to make opportunities equal instead of outcomes. This is due to fact that people are not supposed to be awarded for having expensive taste or wrong choices (Patty & Penn, 2014). The critic argues that it is not clear on the means to use in measuring minimum allocation when taken as an improvement of total equality when framework of utility is not used. The second criticism is based on Bauchanan’s views. Bauchanan’s views are very different from most of economists. Bauchanan highly criticises the maximisation principle that is used in microeconomics (Roth, 1999). The maximisation principle forms a substantial bearing on his critic for SWF. His main criticism is based on the way in which economists approach the topic. He does not view politics as a method of finding truth but rather as a mean of attending and resolving conflicts among individuals and a way of gaining mutual advantage through cooperation. Bauchanan’s disapproves a lot in the welfare economics. He criticises the use of SWF as analytical tool. According to Bauchanan, there is a big difference in deriving SWF from individual ordering which involves decision making process and the problem of testing the individual processes to determine consistency (Pattanaik, 2008). According to Bauchanan, the whole SWF leads to confusion of issues. He proposes removal of entire SWF and look at the implications of the Pareto criterion. He appreciates Pareto criterion and advocates use of the principle of unanimity. There is also shortcoming in determining the appropriate SWF to use. This is an issue that occurs even when there is a general agreement on the importance of SWF function. Social welfare function fails to discuss how agreement can be expressed using basic values. There lacks a general consensus for the policy makers choice to make choice of values (Hendren, 2014). This leads to a spectre of social welfare functions. The public choice school gives another line of criticism. The criticism poses a constraint in application of SWF (Sen, 2014). Through use of SWF, welfare economic analysis is carried out thereby ignoring political institutions and associated activities. The criticism argues that it is important to take account of the political institutions when carrying out economic analysis (Roth, 1999). This leads to an incomplete analysis. Despite the fact that SWF is accepted in theory, the practical issues in using it are many. References Blau, J., & Abramovitz, M. (2004). The dynamics of social welfare policy. Oxford: Oxford University Press. Cnaan, R. A., Dichter, M. E., & Draine, J. (2008). A century of social work and social welfare at Penn. Philadelphia, Pa: University of Pennsylvania Press. Dolgoff, R., & Feldstein, D. (1999). Understanding social welfare. Boston: Allyn and Bacon. Friedman, L.S. (2002). The Microeconomics of Public Policy Analysis. Princeton: Princeton University Press. Gibson, L. R., & Powers, R. C. (2009). The NIP graph of a social welfare function. Social Choice and Welfare, 33(3), 415-421. Hendren, N., (2014). The inequality deflator: Interpersonal comparisons without a social welfare function. Cambridge, Mass: National Bureau of Economic Research Kaplow, L., Shavell, S., & National Bureau of Economic Research. (1999). Any non- individualistic social welfare function violates the Pareto principle. Cambridge, MA: National Bureau of Economic Research. Lang, N. C. (2010). Group work practice to advance social competence: A specialized methodology for social work. New York: Columbia University Press. Maskin, E., Sen, A., & Arrow, K. J. (2014). The Arrow impossibility theorem. New York : Columbia University Press. Pattanaik, P. K. (2008). Rational choice and social welfare: Theory and applications. Berlin: Springer. Patty, J. W., & Penn, E. M. (2014). Social choice and legitimacy: The possibilities of impossibility. Cambridge ; New York : Cambridge University Press. Popple, P. R., & Leighninger, L. (2001). The policy-based profession: An introduction to social welfare policy analysis for social workers. Boston: Allyn and Bacon. Roth, T. P. (1999). Ethics, economics, and freedom: The failure of consequentialist social welfare theory. Aldershot: Ashgate. Schneider, J. A. (2006). Social capital and welfare reform: Organizations, congregations, and communities. New York: Columbia University Press. Sen, A. K. (2014). Collective Choice and Social Welfare. Burlington: Elsevier Science. Tripp, G., Payne, M., & Diodorus, D. (2009). Social capital. New York: Nova Science Publishers. Read More