Chapter 5

Equity and social welfare

Learning outcomes

• Distinguish between the Pareto and Bergson criteria for a welfare improvement

• Discuss Nozick’s entitlement theory and its relevance to the recent history of South Africa

• Explain how a redistribution of income can be justified in terms of the theory of externalities

• Distinguish between the cardinal and ordinal social welfare functions

• Discuss the efficiency implications of policies aimed at redistributing income from rich to poor people.

Potential top-level equilibria

The two-sector model

Implications• Preferred distribution of income• Distribution of incomeCriteria to assess welfare effects of public policy• Pareto criterion• Bergson criterion.

Nozick’s entitlement theory

Justice in acquisition

states that individuals are entitled to acquire

things that do not belong to others or do not place others in a worse position than

before.

Justice in transfer

states that material things can be

transferred from one individual to another on

a voluntary basis, for example, in the form of

gifts, grants, and bequests, or through voluntary exchange.

Rectification of injustice

states that a redistribution

of wealth is potentially justified only if one or both of the first two�principles have been

violated.

Other Pareto criteria

• Externality argument for redistribution• Insurance motive• Altruism

– Ua = f[Ma, Ub(Mb)]

– Ua = g(Ma, Mb)

– 0 > g’(Ma) > g’ > Mb > 0

Bergson criterion

• Social welfare function• Additive (or cardinal) welfare function

– W = Ua + Ub + ...

– W = W(Ua, Ub)

• Ordinal function.

A redistribution of income can be justified on welfare grounds even if it places one or more individuals in a worse position.

Utility possibility curve and welfare maximum

Alternative welfare functions

A competitive equilibrium versus welfare maximum

A competitive equilibrium versus welfare maximum (continued)Ua = Ua(Xa, Ya)

Ub = Ub(Xb, Yb)

W = V [ (Xa + Xb), (Ya + Yb) ]

W = V(X, Y)

Disincentive and savings effects of redistribution

Efficiency considerations

• Willingness to work– Income and substitution effects ((dis) incentive effect)

• Taxation and subsidisation.

The expected benefits of a policy of redistribution should be carefully weighed

against the possible negative effects it might have on labour supply and on

savings and investment, and hence on economic growth in the long term.

Thank you.