Five Theories of Welfare Economics. An Evaluation

Term Paper 2016 13 Pages

Economy - Health Economics






Theories of Welfare Economics

1) Pareto Optimality
2) Kaldor-Hicks Compensation Criterion
3) Scitovsky Double Criterion
4) Social Welfare Function of Bergson and Samuelsson
5) Amartya Sen’s View on Social Welfare

Concluding Remarks



This is a collective analysis of five major economic theories of welfare. Here each of the theories explained separately in a brief manner. The diagrammatic representation is also used here to understand the concepts easily. Further an evaluation of each theory has also provided along with the discussion. This note includes the following five welfare economic theories.

1. Pareto Optimality
2. Kaldor-Hicks Compensation Criterion
3. Social Welfare Function of Bergson and Samuelsson
4. Scitovisky Criterion
5. Amartya Sen’s Theory of Welfare

The analysis and explanation is made on the basis of detailed self study. So I welcome all the suggestions for the improvement of this work.


Cooperation and trust are important in every sphere of society. We often underestimate the role of trust in making our economy work or the importance of the social contact that binds us together (J Stiglits, 2012). Every institution in the society is aiming to maximize their utility or welfare. The peak of happiness of a society can be arrived when the aggregate welfare enlarges. Nowadays, welfare economics has become one of the most important branches of economics. The present modern welfare economics emerged through an evolution process of aggregating different views of eminent economists of different times. It basically deals with the social and individual welfare status through analyzing how the resources of the economy are allocated among the social agents. Welfare economics solves economic decisions through the method of normative economics. Thus value judgment plays a crucial role in the decision making process of policies and programs. The maximization f social welfare is one of the ultimate aims of modern democratic governments. On the other side, welfare is more or less a subjective matter. Its level varies from individual to individual depending on their wants, pleasure, pain and satisfaction. Therefore welfare economics needs to answer highly complicated social issues. Even then, through the process of value judgment, social scientists are finding ways to maximize social welfare based on the rational allocation of total resources among the society. Sometimes, the redistribution of wealth may become necessary to bring social welfare. This can be done through taxation or legislation. In fact, welfare economics is dealing with multi-complex sociological, economical, political and even psychological issues. Moreover, it is purely based on reasoning and critical views. Thus welfare economics is an inevitable one to a society of practicing democracy.

Theories of Welfare Economics

Welfare economic theories are developed by different economists. All of them are not agreeing with a single view that can be used for measuring the social welfare, instead, there exists heterogeneity in the view on welfare. Basically, the explanation of welfare theories can be envisaged under two ways.

Firstly, let’s begin with the idea of Pareto and his followers. According to them, an improvement in welfare can be justified when it benefited to at least one and should not worse off anybody in the society. Further, social welfare can be arrived by adding up all the welfare of individuals. But in many of the real cases, Paretian criterion can’t be applied because some policies may bring benefit to somebody at the cost of another. Moreover Paretian optimality condition is free from the possibility of interpersonal comparisons in terms of utility and welfare. Anyway, Pareto’s view can’t be neglected blindly.

Secondly, according to Samuelsson and Bergson, interpersonal comparison of utility or welfare is possible and it makes a sense of value judgments. It is possible through comparing the utility functions of various individuals and this idea is popularly known as the “Social Welfare Function”. Unlike the Paretian condition, social welfare can be judged even in a condition of increased welfare of some at the cost of another person. This is because; the idea of value judgment is very significant here. For an illustration, suppose the government wants to reduce the inequality through taxation. The taxpayers get worse off and suffer pain. But from the view of normative reasoning, the extreme inequality can’t be judged. Anyway, the following welfare theories are mentioned here.

1. Pareto Optimality
2. Kaldor-Hicks Compensation Criterion
3. Social Welfare Function of Bergson and Samuelsson
4. Scitovisky Criterion
5. Amartya Sen’s Theory of Welfare

1) Pareto Optimality

Pareto’s idea of welfare made an immense role in modern welfare economics. It is been regarded as one of the necessary conditions for social welfare. On the other side, Pareto’s idea is not perfect since it is not free from criticisms. Here there is no scope for value judgment because it accepts the ordinal measurement of utility. And also there is no more scope for interpersonal comparison of utility. Simply Pareto’s criterion states that, an improvement in society can be regarded as welfare even in the case of increasing of welfare of at least one and should not reduce the welfare of anyone in the society. The Pareto’s criterion becomes more complex when welfare of one increases along with that welfare of others decreases. In such cases the optimality and the efficiency idea of Pareto can’t be applied at its best. The theory can be represented using Samuelsson’s indifference curve as follows for the sake of better understanding.

Abbildung in dieser Leseprobe nicht enthalten

Here, in the diagram, there are two type of commodities represented. Necessary commodities on ‘X’ axis and luxury commodities on ‘y’ axis. Tom and Peter are the two persons represented on the ‘x’ axis and ‘y’ axis respectively. ‘IC’ is representing the indifference curve. Suppose, initially the individuals are at point ‘Q’ and consuming combination of both the commodities and enjoying welfare from it equal to that level. Now the Pareto’s condition can be analyzed.

According to Pareto, social welfare may increase even at least one person get better off and others utility remains unchanged or not deceased. So, based on the above diagram, suppose, a policy change leads the welfare level to point ‘C’. It is undoubtedly a welfare increasing condition because both Peter and Tom get more satisfaction than the point ‘Q’. Now take the point A or B. at the point ‘A’, the satisfaction of Peter has increased, but the utility of Tom has neither decreased nor increased. This is also a case of welfare. Similarly, at the point ‘B’, Tom gets better off and Peter never become better off or worse off. Here also social welfare increased. But the critical condition of Pareto’s idea can be finds outside the area of AQB. In such a case welfare of one person has increased at the cost of another. In the diagram, redistribution of welfare to ‘D’ and ‘E’ from point ‘Q’ declines the welfare of Tom and Peter respectively. In these cases, Pareto’s criterion fails to answer the challenge.


Pareto’s criterion of welfare is not free from criticisms even though it is regarded as a revolutionary idea in welfare economics. Some of the critical evaluation point has mentioned below.

Firstly, the idea is not completely free from value judgments. The reason for saying this is that, the idea puts a condition that none of the individual should not get worse off is actually a case of value judgment. In many of the cases of redistribution of wealth or income, somebody should suffer for the betterment of others. Governments are doing such policies to protect the democratic functioning as well as to reduce the level of inequality in the society. But Pareto failed to judge this condition of increasing and decreasing of welfare together in the society.

Another criticism is that, the theory is incapable of focusing towards a highest possible welfare maximizing condition. Pareto just says improvement without any cost is welfare. But there are many levels of possibilities for the improvement. Thus he failed to say a certain level of maximum social welfare. Moreover, the possibility of comparing various increased social welfare conditions is also unquoted.

Another crucial criticism is the argument of Professor Amartya Sen. According to Amartya Sen, wellbeing can be measured on the basis of utility and it has two dimensions like level of happiness and desire fulfillment. But in Pareto’s case, it is possible to have an extreme inequality in the society. Suppose welfare of rich has increase, but welfare of poor has neither declined nor increased. In this case, the social welfare increases based on Pareto’s idea. Amartya Sen says that, welfare is not just narrowed one but it includes various aspects of wellbeing like happiness, freedom, dignity etc. In fact, Amartya Sen criticizes Pareto’s idea from the qualitative aspects as well as the existence of extreme inequality.



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Title: Five Theories of Welfare Economics. An Evaluation