Introduction

This chapter is part of welfare economics. Welfare economics is about the wellbeing of society: which institutions, which policies, which market structures, which distributions of goods or wealth make society better or worse off. This type of question has interested economists since the time of Adam Smith (1723–1790), whose The Wealth of Nations was published in the same year (1776) as the American Declaration of Independence. Welfare economics is easy if society can be modeled as just one person, plus a government deciding on something like a tax policy, and the only question is whether that one person would be better off with policy A or policy B. This is the kind of analysis we will do in Sections 6.2 and 6.3. The appendix to this chapter covers the theory of revealed preference and relates it to some of the Section 6.2 material.

Welfare economics is somewhat more difficult if we want to know how much that one individual prefers policy A to policy B. We look at this issue in Section 6.4.

Welfare economics is complicated if there are two or more people in society, and if we are trying to determine whether policy A is better for the many-person society than policy B. In Section 6.5 we provide an example that touches on the problem, but the many-person model is discussed mainly in the following chapter. A different branch of welfare economics explores the connections between competitive markets and what economists call Pareto efficiency or Pareto optimality. We will do this later, in our chapters on exchange and production economies.