UNIT 15 SOCIAL WELFARE FUNCTION

Structure
15.0 Objectives
1 5.1 Introduction
15.2 Value Judgment
15.3 Social Welfare Function
15.4 Compensation Principle
15.4.1 Kaldor-Hicks Criteria
15.4.2 Scitovsky Reversals and the Double Criteria
15.4.3 William Gorman's Intransitivity Problem
15.4.4 Samuelson's Criteria
15.5 An Appraisal
15.6 LetUsSumUp
15.7 Keywords
15.8 Some Useful Books
15.9 Answer or Hints to Check Your Progress
15.10 Exercises

15.0 OBJECTIVES
After going through this unit, you will be able to:
identify the themes used as value judgment in welfare formulation;
understand the process of constructing the social welfare function and its
analytical significance;
assess the new welfare economics approach through compensation
principle;
explain various criteria ofthe compensation principle; and
understand the intransitivity problem and its significance.

15.1 INTRODUCTION
In the previous unit we have seen two approaches, neo-classical and new
welfare economics, dealing with the norms of efficient resource allocation.
We extend the discussion presently to see the appropriateness of value
judgement in analysing the welfare issues and search for the areas of
development and refinement. In the process, we will discuss the ethical social
basis of welfare function and of compensation principle. We will discuss how
through compensation principle optimum welfare is achieved. We shall also
be able to decipher whether the compensation principle is an improvement
over the earlier attempts or not.

15.2 VALUE JUDGMENT-

Value judgments refer to the conceptions or ethical beliefs of people about
what is good or bad or simply what is desirable or not from the point of view
of the well being of the society. These conceptions or perceptions of the
people in society are based on ethical, political, philosophical and religious
beliefs of the people and are not based on any scientific logic or law. In a
broader sense, 'any statement which implies a recommendation of any kind is
 a value judgment'. This definition covers all ethical judgments as well as Socia'weKarcFunction
statements, which might appear to be merely descriptive, but are in certain
contexts recommendatory, persuasive or influential. Some examples of value
judgments are: 'a country grows faster if profits are taxed lightly'; 'honesty is
the best policy'; 'monopolies need to be controlled'; and 'an essential aim of
public policy anywhere is a reduction in the inequalities of incomes'. In fact,
economist I.M.D. Little has argued that any persuasive statement needs to be
regarded as a value judgment.
Value judgments are basic to welfare economics for a number of reasons.
First, in welfare economics some propositions are formulated about the
welfare of individuals comprising a group; since welfare is an ethical term,
any theorem incorporating the word welfare is also ethical and must rest on
some obvious or hidden value judgments. Second, value judgments are basic
to welfare economics also because it has always been considered to be that
part of economics where prescriptions for policy are studied. No prescriptions
can ever be made without starting explicitly or implicitly with some notion of
what is desirable, good or suitable or simply the social objective. Again, no
objectives can be formulated, or questions of desirability or suitability settled,
without implicitly or explicitly assuming some value judgments.
However, there is no general agreement among economists over the role of
value judgments in welfare economics. Lionel Robbins critised the idea of
value judgments as out of place scientific-objective-analysis. According to
him these must be dealt with descriptively by accepting the values of the
community as observational data.
In the face of such criticisms Kaldor, Hicks and others sought to isolate a
value free, purely objective kernel of welfare economics, which later came to
be known as 'New Welfare Economics'. The chief outcome of their efforts is
known as the 'Compensation Principle'. However, it was later pointed out that
the procedures of the new welfare economics did not dispense with ethical
assumptions such as consumer sovereignty and indifference of resources in
different uses. It was Abram Bergson, by his introduction of the concept of the
Economic Welfare Function, who solved these problems and achieved a
notable isolation and clarification of the function of value judgments in
welfare economics. The economic welfare function was ideally suited to the
formalisation of any set of value assumptions within a welfare analysis, and to
the compact tracing out of their implications. He explicitly introduced a set of
value judgments in the economic welfare function so that, economists can
judge the desirability of certain economic reorganisations or policy changes.
These value judgments are determined by their compatibility with the values
prevailing in the community the welfare of which is being studied.
To illustrate, let us introduce some value judgments that are assumed in most
. welfare studies, and as put forward by Jeremy Rothenberg, in his book, 'The
Measurement of Social Welfare ', (196 1):
1) Non-labor resources employed in different uses. "A shift in a unit of any
factor of production, other than labor, from one production unit to another
would leave economic welfare unchanged, provided the amounts of all
other elements in welfare were constant". In other words, "factory
smoke," etc., are assumed to have no effect on social welfare.
2 ) Consumer sovereignty. "Individual's preferences are to 'count' ". Any
change, which leaves everyone indifferent, has the same level of social
welfare; a change by which one person is better off while everyone else is
indifferent represents an increase in social welfare; a change by which one
Welfare Econor~~ics person is worse off while everyone else is indifferent represents a decrease
in social welfare. In other words, this assumption decentralises the
evaluation of alternatives so that each individual first orders various
alternatives so that these orderings become the determining variables of
social welfare.
3) Equal distribution of "shares". "If the shares of any ith and kth
individuals were equal, and if the prices and wage rates were fixed, the
transfer of a small amount of the share of i to k would leave welfare
unchanged". To put it differently, for given prices and wage rates, any
departure from equal shares will bring about a social welfare decrease; any
closer approximation to it will bring about a social welfare increase.
Moreover, Prof S.K. Nath, in his book, "A Reappraisal of Welfare
Economics", (1969), has identified certain value judgments embedded in
Paretian welfare economics. According to him, "since the Paretian economic-
welfare theory of allocation contains propositions about allocation of
resources which are meant to be suitable, good, or optimum, it is necessarily
based on certain value judgments". The Paretian value judgments are the
following:
1) The concern is to be with the welfare of all the individuals in the society
rather than with that of some mythical entity called 'society' or 'state', or
with that of some special group or class.
2) Any non-economic causes affecting an individual's welfae can be
ignored.
3 ) An individual should be considered the best judge of her economic
welfare; and therefore also of her welfare. This value judgment is often
referred to as that of 'complete consumer sovereignty'.
4) If any change in the allocation of resources increases the income and
leisure of everyone or at least one person (or more strictly one household)
without reducing those of any other, then the change should be considered
to have increased social welfare.
Thus, it can be mentioned that welfare economics cannot be purged of value
judgments. In fact the study of welfare economics has been developed to
make policy recommendations for promoting social welfare and for doing so
economists cannot escape from introducing ethical norms or value judgments.
Therefore, I.M.D. Little in his book, 'A Critique of Welfare Economics'
( 1 957) has observed, "Welfare economics and ethics cannot, then, be
separaied. They are inseparable because the welfae terminology is a value ,
terminology ... Getting rid of value judgments would be throwing the baby with
the bathwater. The subject is one about which nothing interesting can be said
without value judgments for the reason that we take a moral interest in
welfare and happiness".
However, it should not deducted from the above analysis that the explicit
introduction of value judgments makes the study of welfare economics
unscientific. In spite of the explicit introduction in welfare analysis, the.
economist's approach can still be scientific in the sense that one scientifically
deduces the welfare propositions from the given value judgments.

'15.3 SOCIAL WELFARE FUNCTION

Treating a number of economic variables as inputs, a social welfare function
gives a measure of the aggregate material welfare of a society. Abram
 Bergson first introduced the idea of a social welfare function in his article 'A WeifareFueetioo
Reformulation of Certain Aspects of Welfare Economics' in 1938. By
introducing the concept of 'social welfare function', Bergson and Samuelson
approached welfare analysis in a different way. They based the concept of
SWF on ordinal preferences of individuals and argued that welfare economics
is essentially a normative study, but the approach should be scientific despite
the fact that the incorporation of value judgments in it is simply unavoidable.
It would be prudent to have a brief overview of some alternative welfare
functions, which will be helpful in bringing out some embedded ethical
judgments. The classical welfare function was put forward by Bentham, Pigou
and Marshall, popularly known as 'Benthamite welfae function'. According
to them, social welfare is the sum of cardinal utilities obtained by all members
of a society. In algebraic form, this can be denoted as:
W=U1+U2+............+Un
where W denotes social welfare, UI, Ub etc; represent the cardinal utilities of
the individual members of the society. The goal of a society is to maximise
social welfare, that is, the aggregate of the utilities of the individual members
I of society. Given this, maximum social welfare will be achieved if income is
so distributed that marginal utility of income is equal for all individuals in a
society. Moreover, the classical viewpoint is that maximisation of social
welfare is achieved only with equal distribution of income.
I Another important social welfare function has been propounded by the noted
Ik philosopher John Rawls. Rawls analysed welfare economics by posing a
problem: "what type of welfare criterion would be adopted by the society
when it is in such an initial position where everybody has to behave under
uncertainty about how the welfare criterion chosen will ultimately aflect his
utility or welfae". Assuming that individuals are risk averse, he asserts that
such a welfare criterion will be chosen that deviations from perfect equality
would be made only when with unequal distribution of utilities, the worst oSf
individual is better off actually than under equality conditions. This can be
stated algebraically as follows:
W (U1, U2, U3,.............U,) = min (Ul, U2, U3,. ..............Un)
This implies that social welfare of resource allocation depends only on the
worst off individual, that is, the person with minimum utility.
Social welfare fhnction is an ordinal index of society's welfare and is a
function of the utility level of all individuals comprising the society. The
c "Bergson-Samuelson" social welfare fhnction (SWF) can be expressed in the
following general form:
W = W (u', u2,.., uH),
where "society's" welfare denoted by W, is merely a hnction of the utilities
of its constituent members, uh,h = 1, 2, ........ H, where H are the number of
households in the society. In other words, u', u2,.., uHrepresents the ordinal
utility indices of different individuals or households in the society. The ordinal
utility index of an individual depends upon the goods and services she
consumes and the magnitude and kind of work she does and the amount of
leisure she enjoys.
The Bergson-Samuelson SWF can be explained with the help of the grand
utility possibilities frontier (GUPF). We know that every point on the GUPF is
a Pareto-optimal allocation, and thus it seems that no point is necessarily
preferable to another. The Bergson-Samuelson SWF shows that, given the set
Welfare Ecoeomicr of Pareto-optimal points, which is' more desirable from "society's" point of
view, where the notion of social desirability was subsumed in a social welfare
function.
Heuristically, we can envisage the upper contour set of the SWF as a set of
"social indifference curves" in utilities space, as shown in Figure 15.1.
According to Bergson, there are some desirable properties of a society which
are captured by the SWF: for instance, social welfare increases if the utility of
any of its members increase and none decrease (the "Pareto principle") that
yields northeasterly ascendance of the social indifference curves. It is worth
mentioning that the consideration of fairness and equity are incorporated into
the SWF and are reflected in the shapes of social indifference curves. In other
words, it can be argued that equity is socially desirable; consequently, extreme
distributions of utility ought to be given less weight. Thus, the convexity of
the social indifference curve needs to be accepted and like the usual
indifference curves they are also non-intersecting.

Fig. 15.1: Social Welfare Function and the Social Optimum

By superimposing social indifference curves on the GUPF as in Figure 15.1,
we can see that allocation S = (uA*, uB*) is the point on the GUPF that
attains the highest social indifference curve, and maximises the social welfare
function, yielding social welfare index W*. Thus, the "social optimum" is
determined by the tangency of the social indifference curves and the GUPF.
The SWF as depicted in Figure 15.1 can be explained by the following
functional form:
w = n h=,H w h ) a
where ahare the weights assigned to each household in the social welfare
function. Such a function yields the convex social indifference curves in
Figure 15.1 and is sometimes called a "Bernoulli-Nash" social welfare
function.
It is to be noted that the slope of the social indifference curves is equal to the
negative of (6w/6uA)/ (6w/6uB). This last term in the expression is the
 "marginal rate of social substitution" between consumers A and B, or Social Welfare Fnactioa
MRSSA~. Now, we know that the slope of the GUPF will be merely the ratios
of the marginal utilities of income of households A and B, thus the tangency
condition is that:
MRSSAB= (6WI6 U ~ ) / ( G W / G U
=~) B, and (6w/6uA)/ = (6W/6 uB)/
pB, or the social marginal utility for each household is equal across
households.
We can extend this explanation to analyse some alternative welfare function
as
mentioned above. As per the classical or Benthamite or "utilitarian" social
welfare function, the SWF can be constructed as a linear sum of weighted
utilities, e.g;
1
W=Ch=,Ha hUh
which is a direct sum. Thus, as stipulated by Jeremy Bentham and the
Utilitarians, this one maximises the (weighted) sum of individual utilities and
1 yields linear social indifference curves (WB9,WB*, WByyb as shown in Figure
15.2 below.
I
U" 4

C
Fig. 15.2: Benthamite and Rawlsian Welfare Function
Bergson-Samuelson SWF states the conditions for "social justice", as that,
'the marginal rate of social substitution between households A and B is equal
to the ratio of marginal rates of substitution of A and B. In other words, this
implies that the allocation of goods is done in such a manner so as to have the
utility distribution compatible with the "worthiness" of the individuals
according to the social welfare function.
Thus, social welfare is a hnction of the levels of utility of members in the
society. Alternatively, the social welfare function can be expressed as a
function of other variables relevant to welfare, such as income or life
expectancy. The form of the social welfare function can be seen as expressing
a statement of the objectives of a society. For example, take a social welfare
function:
wetfare ~womics where W is social welfare and Y, is the income of each of the X~ individual in
a society. In this case, maximising the social welfare function means
maximising the total income of the people in the society, without regard to
how incomes are ,distributed in the society. Alternatively, consider the Max-
Min utility function:
W=min (Y1,Yz ,....,Yn)
Here, the social welfare of the society is taken to be related to the income of
the poorest person in the society, and maximising welfare would mean
maximising the income of the poorest person without regard for the incomes
of the others.
These two social welfare functions express very different views about how a
society would need to be organised in order to maximise welfare. While the
first emphasises the total incomes, the second considers the needs of the
poorest.
However, often choice of such a function is considered part of political
economy. Choosing between two such functions may be a matter of tolerances
versus preferences, or some broader political or ethical issue that cannot be
resolved by economics at all. A related problta is the need of individual
capital for rest and recreation, which prevents anyone from actually
maximising the total income. This is at the root of many of the balanced
growth assumptions of macroeconomics: Unless a uniform social welfare
function is chosen across an entire society, growth is not balanced. Due in part
to this concern, more direct means of measuring well-being than "total
incomes" or GDP are required by modem human development theory.
Amartya Sen makes the point more directly: "What is the relation between our
wealth, and our ability to live as we would like?" Without answering this
question, income and welfare are only indirectly related.
Check Your Progress 1
1) What is the meaning of value judgment?

......................................................................................
2) Write the general form of social welfare function.

......................................................................................
3) What is social optimum and how is it determined?
 Social Weltare Function
15.4 COMPENSATION PRINCIPLE
As discussed in the previous unit, Pareto criterion simply states that an
economic change, which harms no one and makes someone better off,
indicates an increase in social welfare. This does not apply to those economic
changes, which harm some and benefit others. In terms of Edgeworth Box
diagram, Pareto criterion fails to say as to whether or not social welfare
increases as movement is made in either direction along the contract curve
because it rejects the notion of interpersonal comparison of utility. Thus, this
criterion leaves a considerable indeterminacy, for, there are numerous Pareto
optimum points on the contract curve. Economists like Kaldor, Hicks and
Scitovsky have made efforts to evaluate the changes in social welfare
resulting from any economic reorganisation, which harms somebody and
benefits others. They have put forward a criterion known as the Compensation
Principle based on the following assumptions:
The satisfaction of an individual is independent of others and she is the
best judge of her welfare.
There exist no externalities of consumption and production.
The tastes of individuals remain constant.
The problems of production and exchange can be separated from those of
distribution. Compensationprinciple accepts the levels of social welfare to
be a function of the production. Thus, it ignores the effects of change in
distribution on social welfare.
Utility can be measured ordinally and interpersonal comparisons of
utilities are not possible.
Given the above assumptions, Hicks, Kaldor and Scitovsky have claimed
to formulate a value free objective criterion of measuring the changes in
social welfare with the help of the concept of 'compensatingpcryments'.
15.4.1 Kaldor-Hicks Criteria
Let us consider the Edgeworth-Bowley box as shown in Figure 15.3 below. It
is evident that allocations D and F (and indeed, all allocations in the "lens"
formed by u*(E) and u~(E))are Pareto-superior to E, but allocation C cannot
be compared to either D, F or E.
An alternative criterion of judging whether an allocation was "preferable" to
another was proposed by Nicholas Kaldor in his article, 'Welfare Propositions
of Economics and Interpersonal Comparison of Utility', published in The
Economic Journal, September, 1939. According to Kaldor's welfare criterion,
if a certain change in economic organisation or policy makes some people
better off and others worse off, then that change will increase social welfare, if
those who gain from the reorganisation could compensate the losers and still
be better off than before. In other words, Kaldor argued that an allocation is
preferred to another if by moving from the second to the first, the "gainer"
from the move can, by a lump-sum transfer, compensate the "loser" for her
loss of utility and still make a gain in utility for herself. Hicks stated that, ' i f A
is made so much better by the change that he could compensate B for his loss
and still have something left over, then the reorganisation is unequivocal
improvement'. To put it in other way, a change is an improvement if the losers
in the changed situation cannot profitably bribe the gainers not to change from
the original situation. Hicks has given his criterion from the loser's point of
view, while Kaldor had formulated this criterion from the gainer's point of
Welfare Economics view. Thus, the two criteria are really the same though they are exposited
differently. That is why they are generally called by a single name, 'Kaldor-
Hicks Compensation Criteria'.
Suppose we want to reorganise the allocation by moving from allocation E to
allocation C. This shows that, individual A gains in utility (from u ~ ( E )to
uA(c)) and individual B loses (from u ~ ( E )to uB(c)). This implies that, E and
C are not Pareto-comparable. However, if we move to allocation C, individual
A can pay individual B a portion of her gains so as to keep individual B at her
old utility level u~(E).For instance, A can pay B the amount xAc- x A(thus ~
she moves to point F) so that B retains the same old utility level uB(E) while
the utility of A is now u~(F).As the utility of A at allocation C is greater than
that at F, (xAc> xAF),individual A makes a net gain (xAE+ (xAc- X ~ Fplus )
whatever she gained in terms of good Y. Thus, as shown in the figure when
U,(F) > u~(E), it is worthwhile for her to propose moving to C and then
paying individual A the amount xAC - xAF,thereby moving the economy to F.

Fig. 15.3: Kaldor Compensation Criteria

Now, if the Kaldor compensation criteria implied merely that we moved from
E to F, then it is not an improvement on the Pareto criterion as F is obviously
Pareto-superior to E. However, Kaldor's innovation is to propose that
allocation C is superior to that of E because it is possible for A to compensate
B and still be better off. The crucial point is that A can compensate B, and not
that A will compensate B. Thus, the move from E to C is actual, but the move
from C to F is only hypothetical. Thus, Kaldor proposed that we can compare
Pareto-incomparable points via the "hypothetical cornpernation" test. In sum,
an allocation is preferable to another if it is possible to hypothetically
redistribute goods so that a Pareto-improvement occurs.
It is to be noted that, while the Kaldor criteria can be used to compare Pareto
sub-optimal points with each other and with Pareto optimal points, it remains
incomplete. For, it cannot compare Pareto-optimal points with each other. For
example, a movement from one Pareto-optimal allocation to another by C and Socia' WcH8'.rr
F in Figure 15.3 will require, via compensation, that the winning individual
surrenders all her gains, such that she will be not be better off.
An alternative test, proposed by John Hicks was that of "bribery" by the losers
as opposed to "compensation" by the winners. An allocation would be
preferable to another if, given a proposed move from the second to the first,
the losers would not be able to bribe the winners into not undertaking the
move. If they were willing to give such a bribe and the winners were willing
to take it instead of moving to the proposed allocation, then the proposed state
would not be superior. Thus, in the case of Figure 15.1 1 we might think that
individual B might offer individual A, a bribe not to move from allocation E
to allocation C, but clearly A would not accept. There is thus, from E, no
lump-sum transfer that individual B would be willing to give individual A that
would make A no worse off than in state C. As a consequence, C is preferred
to E by the Hicks criteria. Conceptually, then, the Hicks criteria reverts the
Kaldorian notion: C is preferred to E if from E it is not possible to undertake a
hypothetical lump-sum redistribution to achieve a Pareto-improvement over
state C.
The Kaldor-Hicks criteria in a production economy can be explained through
the GUPF and the various allocation possibilities within them. Thus, an
allocation is superior to another if it is possible that the winners compensate
the losers for moving to the former (Kaldor) or if the losers bribe the winners
not to move to the former (Hicks). In a production context, there are now two
forms of the Kaldor criteria:
The strong Kaldor criteria requires any compensations to be a lump-sum
transfer between individuals and thus, by not allowing production to
change as part of the compensation, one is confined to making transfers
within a given UPF;
The weak Kaldor criterion allows production to change as part of the
compensation, and thereby the entire GUPF is available.
It is clear that the weak Kaldor criteria can compare all Pareto-sub-optimal
points in the GUPF. However, the strong criteria cannot do so. This is the
complication that Kaldor criteria bring in a production economy. This is
explained in the Figure 15.4 below.
As shown in the figure, there are two Utility Possibility Frontiers (UPF's).
Suppose we want to compare points E and G. Obviously, E is Pareto-
inferior to F and G is Pareto-inferior to D, but it is not possible to compare
E and G by the Pareto criterion. Let us then employ the strong Kaldor
compensation test: if we move from point E to point G, it is obvious that
individual B is the winner and individual A the loser, However, B can
(hypothetically) compensate A for her loss and still remain better off by
offering a compensation that takes the allocation to point H (note that both
G and H are on the same frontier, UPFF - this is the requirement of the
strong Kaldor criteria). At H, individual A would be at her old utility level,
u*(E), but individual B would have utility u ~ ( H )> uB(E). Thus she is
strictly better off and by the Kaldor compensation criteria allocation G is
superior to allocation E.
Welfare Economics

Fig. 15.4: Incomparability with Strong Kaldor Compensation Criteria

However, suppose we begin at G and want to move towards E. This implies
that Individual A is now the winner and B the loser. Yet, individual A can
hypothetically compensate individual B by offering a transfer payment that
takes the allocation to point K. At K, individual B stays at her old utility level
u~(G),but individual A improves her utility position from u*(G) to u*(K).
Thus, by the strong Kaldor compensation criteria, E is superior to G. And by
the same criteria, G is superior to E. Thus points E and G are not consistently
comparable.
15.4.2 Scitovsky Reversals and the Double Criteria
Not only the strong Kaldor criteria is unable to compare various allocations
consistently, but also there are problems regarding the weak Kaldor criteria
for comparisons of welfare under different types of change. The famous
Scitovsky reversal paradox, first identified by Tibor Scitovsky, uncovered an
important drawback of the weak Kaldor criterion. Scitovsky pointed out that if
some situation position, say B, is shown to be an improvement over position
A on Kaldor-Hicks criterion, it may be possible that position A is also shown
to be an improvement over B on the basis of same criterion. For getting
consistent results when position B has been revealed to be preferred to
position A on the basis of a welfare criterion, then position A must not be
preferred to position B on the same criterion.
Suppose in a production economy, the production conditions change due to
change in technology. This will lead to the shift of the position and as a result
the move from PPFD to PPFF (Figure 15.5). In order to judge whether this
technological change improved or worsened welfare, the corresponding
Pareto-optimal points D and F represented by the tangencies of CICD with
PPFDand CICFwith PPFF can be compared.
 Social WcLrc Fuactioa

Fig. 15.5: Scitovsky Reversal

It can be seen that CICD and CICF intersect each other, which implies that
intersecting CICs imply Pareto-improvements. This means that F is Pareto-
superior to E. Moreover, E represents the same level of "aggregate" utility as
D as they are on the same CICD.Thus, from D, it is possible to hypothetically
redistribute goods and outputs so that we obtain a Pareto-improvement.
According to the weak Kaldor criteria, situation F is superior to D. However,
by a reverse argument, it can be seen that as a result of the movement from
PPFF to PPFD, D is Pareto-superior to G and G yields the same level of
"aggregate" utility as F as it lies on CICF. Thus, by the weak Kaldor criteria
again, situation D is ranked higher than that of F. There is a "reversal" of
rankings between D and F by the weak Kaldor criteria as F is better than D
and D is better than F.
Therefore, Scitovsky suggested that resolution to this reversal paradox might
be done by combining both the Hicks and Kaldor criteria. This is explained in
the figure above. As can be seen from the figure, the movement from D to F
fulfills the Kaldor criteria but not the Hicksian one, asfiom D, it is possible to
undertake hypothetical lump-sum redistribution within PPFD that achieves a
Pareto-improvement over F (e.g., a point slightly above G in PPFDis a Pareto-
improvement over G and thus over F).
The Scitovsky double criteria state that an allocation is preferred to another if
it fulfills both the Kaldor and Hicks criteria. This would, it seems, eliminate
Scitovsky reversals as that depicted in Figure 15.5 above. Thus when the two
utility possibility curves are non-intersecting and change involves movement
from a position on a lower utility possibility curve to a position on a higher
utility possibility curve, the change raises social welfare on the basis of the
Kaldor-Hicks-Scitovsky criterion. This occurs only when a change brings
about increase in aggregate output or real income.
15.4.3 William Gorman's Intransitivity Problem
William Gorman demonstrated that while the Scitovsky double criteria rules
out Scitovsky reversals, it does not rule out intransitive chains. For instance, it
may be that an allocation G is preferred to allocation D, allocation D is
Welfare Ecommkr preferred to allocation F but allocation F is not preferred to allocation G. This
is shown in Figure 15.6, where there are three PPFs (PPFD,PPFF and PPFG)
and three CICs corresponding to the Pareto-optimal allocations on each PPF
(allocation D on CICD,allpation F on PPFFand allocation G on PPFG). It can
be seen that unlike in Figure 15.5, D is superior to F by the Scitovsky double
criteria because it is better than F by both the Kaldor and Hicks criteria and
moreover, CICDdoes not intersect PPFFwhile CICF intersects PPFD.

Fig. 15.6: Scitovsky Double Criteria - and Gorman Intransitivity

The problem of intransitivity can now be visualized in Figure 15.6. As noted,
by the double criteria, D is preferred to F. By the same double criteria, it can
be argued that G is preferred to D, as CICDintersects PPFGbut CICGdoes not.
However, G and D do not fulfill the double criteria, as CICF intersects PPFG
and CICG intersects PPFF, a situation similar to the one described in Figure
15.5. Thus, by the Scitovsky double criteria, G is preferred to D, D is
preferred to F but G is not preferred to F. Consequently, although the
Scitovsky double criteria rules out ranking reversals and although G is not
preferred to F, F is also not preferred to G and they are merely incomparable,
which implies that the ranking is intransitive.
15.4.4 Samuelson's Criteria
A way out of Gorman's intransitivity problem has been proposed by Paul
Samuelson, popularly known as the Samuelson Criteria. The Samuelson
criteria argues that a situation G is preferred to a situation D if all hypothetical
redistributions from situation G will achieve utility allocations that are
superior to some hypothetical redistributions from situation D and that no
hypothetical redistribution from situation D will yield utility allocations that
are unattainable through any hypothetical redistributions from situation G. in
other words, the utility space lies everywhere above UPFD. In production
space, it requires that PPFG intersects the interiors of CICDand the interior of
any other CIC tangent to PPFD.Clearly, this will often require that PPFG lies
everywhere above PPFD - as in Figure 15.6. Naturally, if we deal exclusively
with PPFs of this type, neither Scitovsky reversals nor Gorman intransitivities
arise. But it also obviously highly restrictive as it rules out quite reasonable
 situations (e.g., those depicted in Figures 15.5 and 15.6). Thus, in this sense, Socia1Welfare Fusetiom
the Samuelson criterion is far more restrictive than the Kaldor, Hicks or
Scitovsky double criteria.
Check Your Progress 2
1) What are the assumptions of compensation Principle?

......................................................................................
2) Differentiate between Kaldor and Hick compensation principle.

......................................................................................
3) What are Scitovsky's double criteria of compensation?

15.5 AN APPRAISAL
In sum, disregarding the problems inherent in the Kaldor, Hicks and Scitovsky
criteria, the question must be raised again: are these objective criteria make
any sense? Ethically, of course, the Kaldor criteria is easily disputed as it is
only a "could" and not a "would" or even a "should". As In M.D. Little
writes, in his famous critique:
"It seems improbable that so many people would, in England now, be
prepared to say that a change, which, for instance, made the rich so much
richer that they could (hut would not) overcompensate the poor, who were
made poorer, would necessarily increase the wealth of the community."
.
A point that has been reiterated by many contemporaries' economists such as,
Baumol, Reder and Samuelson.
However, there were three lines of defense followed by the advocates of the
' compensation principle. The first was to agree and make the "could" into a
"would", i.e; to have the winners actually compensate the losers. This, of
course, leads to an improvement of sorts; the practical objection that arises is
that once we are at a new allocation, winners are unlikely to surrender any of
their gains.
The second defense, pursued by Hicks (1941), was that even if the losers do
not get compensated in the move, they might still benefit in the "long-run" if
the criteria were followed consistently by the society. This argument is similar
to that of "trickle-down" theory and that support for free trade. Some people
may be worse off in the short-run, but in the long run, everyone will be better
off. The underlying assumption, of course, is that at some point, those who
lost utility initially will come across a possible move in which they benefit and
welfare Economics a society which follows the Kaldorian rule will move to it and thus they will
gain in the end. Of course, as Little notes, this is completely hypothetical.
There is nothing to guarantee that there will eventually be a move in which the
initial losers will be the ultimate winners.
The third (and perhaps considered better) line of defense is that the Kaldor-
Hicks criteria merely lay out what is economically possible and that it is up to
policy-makers, on the basis of their own value judgments, to choose which
move to make and whether compensation of the losers should be forced. Thus,
they argue, they are merely underlining that certain options may be more
economically possible than others, but they are still only options. The final
decision will require more philosophical, ethical and political considerations
to be brought into the story.

15.6 LET US SUM UP

Value judgments are crucial in welfare analysis and hence the analysis cannot
be purged of them. However, despite the explicit introduction of value
judgments, the economist's approach can still be scientific in the sense that
one scientifically deduces the welfare propositions from the embedded value
judgments in the welfare analysis. In fact value judgements play a role in
formulating social welfare function, which is a measure of social welfare of
society. There are different types of social welfare functions. The classical or
Benthamite SWF and the Rawlsian ethical SWF emphasises on the cardinal
approach, while the Bergson-Samuelson SWG is based on ordinal approach
and hence scientific. However, the construction of SWF is a matter of political
economy.
We also analysed the compensation principle as an improvement over the
Paretian optimality, as it evaluates the changes in social welfare as a result of
any economic reorganisation, which harms somebody and benefits others,
neglected by the indeterminate Paretian optimality analysis. We also discussed
the two different ways of Kaldor and Hicks exposition of Pareto optimality
from the gainers and loser's point of view respectively. We explained how
Hicks criterion revert the Kaldor's criterion. Then we examined the Scitovsky
reversal criteria and the Gorman's problem of intransitivity and how
Samuelson's criterion offers a solution. We summed-up by pointing out that
disregarding the problems inherent in the above criteria, whether these
objective criteria make any sense or not and came to the conclusion that
ethically, Kaldor criteria can be easily disputed as it is only a 'could and not a
'would' and a 'should'.

15.7 KEY WORDS

Benthamite or Utilitarian Welfare Function: A utilitarian welfare hnction
(also called a Benthamite welfare function) sums the utility of each individual
in order to obtain society's overall welfare. Everyone is treated the same, no
matter what their initial level of utility is.
Hicks' Criterion: An activity will contribute to Pareto optimality if the
maximum amount the losers are prepared to offer to the gainers in order to
prevent the change is less than the minimum amount the gainers are prepared
to accept as a bribe to forgo the change.
Kaldor Criterion: An activity will contribute to Pareto optimality if the
maximum amount the gainers are prepared to pay is greater than the minimum
amount that the losers are prepared to accept.
 Max-min Criterion: 'Welfare is maximised when the utility of those society We*mrcFuoction
members that have the least is the greatest'. No economic activity will
increase social welfare unless it improves the position of the society member
that is the worst off.
Social Welfare Function (SWF): A function that measures the material
welfare of a society using a number of economic variables.
Value Judgment: Ethical beliefs of people about what is good or bad, not
based on scientific logic or law

3 15.8 SOME USEFUL BOOKS

H. L. Ahuja (1997), Advanced Economic Theory, New Delhi: S.C.Chand &
Company Ltd
I
Paul A. Samuelson (1947), Foundations of Economic Analysis. 1983 edition,
Cambridge, Mass: Haward University Press.
S. K. Nath (1969), A Reappraisal of Welfare Economics, London: Routledge
and Kegan Paul Ltd.

15.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS
Check Your Progress 1
1) Ethical beliefs of people about what is good or bad not based on
scientific logic or law.
2) W = W (u,' u2..............
1 u4)
3) Social optimum is determined by the tangency of social indifference
curve and grand utility possibilities frontier
,
I
Check Your Progress 2
1) See 15.4 and answer

I 2) Hick Criteria revert the Kaldorian notion. See 15.4.1

3) An allocation is preferred to another if it satisfies both Kaldor and Hicks
criteria.

15.10 . EXERCISES
I) Write short note on value judgments and their role in welfare analysis.
1.
2) What do you mean by social welfare function? Explain different
4 approaches to it.
t Critically evaluate compensation criteria. Do they serve any purpose in
3)
welfare analysis? Explain.