Pigovian Welfare Economics

Meaning of Welfare Economics

According to Pigou, welfare resides in a man’s state of

mind or consciousness which is made up satisfactions or utilities.
The basis of welfare hence is necessarily the extent to which an
individual’s desires are met. Social welfare is regarded as the
summation of all individual welfares of society. Since general
welfare is a very wide complicated and impracticable notion,
Pigou delimits the range of his study to economic welfare. He
therefore, defines economic welfare as “that part of social welfare
that can be brought directly or indirectly into relation with the
measuring rod of money.” Thus economic welfare, in the Pigovian
sense, implies the satisfaction of utility derived by an individual
from the use of exchangeable goods and services.

Pigovian Welfare Conditions

1. The first condition states that welfare is said to increase

when national income increases. Given the same tastes and
income distribution, an increase in the national income
represents an increase in welfare. Pigou contends that in
most cases the national income would increase even though
the disutility of work also increases.

2. Second, for welfare maximisation the distribution of the

national income is equally important. It national income
remains constant, transfers of income from the rich to the
poor would improve welfare. According to Pigou such
transfers mean less to the wealthy than to poor, as a result
the economic position of the latter is raised. This welfare
condition is based on the dual Pigovian postulates of ‘equal
capacity for satisfaction and diminishing marginal utility of
income.’

Pigou argues that different people derive the same satisfaction

out the same real income and that “People now rich are different
kinds from the people now poor having in their fundamental
nature greater capacities for enjoyment.”

Causes of Divergences Between Private and Social Costs and

Returns

According to Pigou, it is self-interest that leads to the equality

between private and social costs and returns. But certain business
practices tend to foster rigidities and create divergences between
private and social costs and returns which can be widened by
variations in demand, tastes, cyclical fluctuations, war and the
rise of new industries.

The private product diverges from the social product due to the
existence of external economies or diseconomies thereby leading
to divergences between private and social costs and benefits.

1. External Economies of Production – When some firm renders

a benefit or cost of a service to other firm without
appropriating to itself all the benefit or cost of the service, it
is an external economy of production. External economies of
production may arise when the expansion of a firm makes it
possible for other firms in the industry to obtain their inputs
like rained labour force, raw materials etc. at low rates. In all
such cases, social marginal benefits exceed the private
marginal benefits and the private costs exceed the social
costs. For the expanding firm does not receive any
remuneration for the costs incurred by it and the benefits
which its has conferred on others.

2. External Diseconomies of Production – External

diseconomies of production also lead to divergences
between private social costs and returns when the
production of a commodity or service by a firm affects
adversely other firms in the industry. Prof. Pigou’s example
of air pollution explains these divergences. Suppose a factory
is situated in a residential or populated area and it emits
smoke. The smoke from the factory soils clothes, cleaning of
 house hold articles and rooms and cleaning and painting of
buildings and enhanced medical expenses.

3. External Economies of Consumption – External economies of

consumption arise from non-market interdependences of the
satisfactions enjoyed by different consumers. An increase in
the consumption of a good or service which affects favorably
the consumption patterns and desires of other consumers is
an external economy in consumption. When an individual
installs a TV set, the satisfaction of his neighbors increases
when they and their children view the various programs.

4. External Diseconomies of Consumption – When the

consumption of a good or service by one consumer confers a
disadvantage or affects adversely the consumption patterns
and desires of other consumers, it is an external diseconomy
of consumption. Diseconomies of consumption especially
arise in the case of dress fashions and articles of conspicuous
consumption.

5. The case of Public goods – Another cause of divergence

between private and social benefits is the case of public
goods which Pigou completely ignored. Prof. Baumol defines
a public good as “one whose consumption by one individual
does not reduce its utility to any other individual.” The
consumption of public goods is joint and equal. Certain
services provided by the government are public goods such
as national defence, public safety, courts for the
administration of justice, disease control etc. the benefits of
public goods are indivisible.

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