SESSION 5

…IN WHICH WE EXAMINE THE FUNDAMENTALS OF SOCIAL CHOICE AND

HOW SOCIETIES CAN MAKE DECISIONS ABOUT WELFARE.
FROM PARETO EFFICIENCY TO WELFARE

• As mentioned earlier, Pareto efficiency can accommodate situations where one person has
everything to one where no one envies another. Which exact Pareto optimal situation to
choose?
• Important point: Pareto optimality does not allow you to make inter-personal
comparisons of utility. Any point on the contract curve is valid.
• The question of how society can decide between several different outcomes is determined
by the field of social choice.
• Welfare function: A function that combines all individuals’ utilities and welfare in order
to determine the best possible outcome.
VOTING PARADOXES

• It might be very hard for society to aggregate individual preferences to get a coherent
outcome! Consider three different outcomes, x, y and z. 3 different individuals A, B and
C who have different well-behaved preferences for these outcomes:

Person A Person B Person C 2 out of 3 prefer x to y (Who?). Similarly, 2 out of 3

prefer y to z and z to x.
x y z Even if individuals’ preferences transitive, society’s
preferences may not be.
y z x Here, outcome depends on pattern of voting.
If people first vote on x vs y, then z, z will win.
z x y If people first vote on z vs x, then y, y will win.
This is Condorcet’s paradox.
Change the order of voting, outcome will change.
RANKED VOTING

• Imagine 2 individuals, with preferences across x, y and z. Now, individuals rank the
outcomes they prefer.
Person A Person B Imagine only x and y available. A ranks x 1, y 2. B does the
x y opposite. Aggregate ranks for x and y is now 3. Tied voting.
But now z introduced. A ranks x=1, y=2, z=3. B ranks y=1,
y z z=2, x=3.
z x Now x ranked 4, y ranked 3. Now y beats x.
Introduction of potential outcome z can change outcome of
the vote. Potential for manipulation of voting outcomes.
ARROW’S IMPOSSIBILITY THEOREM

• Assume the following desirable properties we may want for our social decision
mechanism.
• 1. Given complete, reflexive, transitive individual preferences, social decision mechanism
should also satisfy the same properties.
• 2. If everyone prefers x to y, then social preferences should rank x to y.
• 3. Preferences between x and y should depend on how people rank x and y, not how they
rank other alternatives (Independence of Irrelevant Alternatives, or IIA).
• Arrow’s Impossibility Theorem: If a social decision mechanism satisfies properties 1, 2
and 3, then it must be a dictatorship: all social rankings are the rankings of one
individual.
• Dictator here does not mean Hitler. It means a single voter whose preferences will always be
satisfied no matter what the method of voting will be (as long as the voting satisfies the basic
conditions specified in the previous slide).
• For e.g., consider the voting examples given above (slides 3 and 4). Simple majority voting
violates transitivity. Ranked voting violates IIA; the choice between x and y depends on
whether or not z is introduced.
• If we construct a mechanism of choice to ensure transitivity and IIA satisfied, there will be at
least one voter whose preferences will be equal to the final choice, and hence her preferences
will always be satisfied.
SIMPLE ILLUSTRATION OF THE BASIC ISSUE

• Consider choice between three cuisines for lunch: Italian, North Indian, South Indian.
There are ten people. These ten individuals have to vote to choose one item for lunch
everyday.
• Four people have preferences: I-N-S.
• Three have preferences: N-S-I.
• Three have preferences: S-N-I.
• Imagine simple voting between Italian and South Indian. South Indian would win (by
how many votes?). Now imagine North Indian added.
• IIA assumption says that choice between South Indian and Italian should not be swayed if
new alternatives added. If S>I, addition of N must ensure S chosen over I.
• But given previous alternatives, if choice now between S, N and I, there is a three-way
choice. To preserve IIA, either S or N should win.
• Given simple majority voting, I would win. IIA violated. Only way to ensure this doesn’t
happen is to impose a choice pattern, such as N-S-I. But this benefits the three people
with this preference, who are, in effect, “dictators”, because their choice always prevails.
• Some suggestions: Drop IIA. Transitivity makes sense at individual level, may not hold
at social level.
SOCIAL WELFARE FUNCTIONS

• Assume that we have figured out a way to deal with Arrow’s Impossibility Theorem. We
can construct social welfare functions which aggregate individual preferences.
• Assume all individuals have well-behaved utility functions. Utility depends only on the
consumption of goods, not on what others consume.
• Social welfare S = f(U1, U2…… Un) where U1, U2……Un are the utility functions of
individuals 1 to n.
• S is an aggregation of individual utilities. Different philosophical ideas regarding how
social welfare is determined according to the needs and choices of individuals will give
us different functional forms of S.
 UTILITARIANISM
Jeremy Bentham (1748-1832). English philosopher, leading
proponent of the school of philosophy called Utilitarianism,
best characterized by the phrase “Greatest good for the
greatest number”.

Fun (!) fact: in his will, donated his body to science for
dissection, and wanted his mummified head and skeleton to be
displayed. His head was mummified badly, and a replica
made, which is now on display in University College, London.
 WHAT IS UTILITARIANISM?

• John Stuart Mill: “The utilitarian doctrine is, that happiness is desirable, and the only thing
desirable, as an end; all other things being only desirable as means to that end.”
• Four important aspects:
• i. Consequentialism: Outcomes are what is important. (The opposite, that actions are good
or bad according to prior rules, is called deontology).
• ii. Welfarism: Only welfare or well-being of individuals matters.
• iii. Impartiality: All treated equally. Equal weight to be put on everyone’s interests, and
identity should not matter.
• iv. Aggregationism: The value of the world is the sum of its constitutive parts.
• Utilitarianism argues that it is the consequences of our actions that are the most important
.
No action or no individual is important in and of itself. (Opposite view, that some rules
are important, is deontology.)
• All individuals are equally worthy of consideration. Racism, sexism, casteism etc are
invalid ways of seeing the world, since every individual must be considered equally when
we consider our actions. A committed utilitarian, therefore, must always donate
financially to help charities and others in need.
• While utilitarians would caution against using simplistic calculations of utility, in some
thought experiments, it could be argued that sacrifice of some for greater good can be
accommodated in a utilitarian framework.
SOME UTILITARIAN DEBATES

• On animal rights: Why is it morally justified to experiment on animals and not on

humans?(Those interested in animal rights should read Peter Singer.)
• On charity: should we continue to spend on luxuries for ourselves when there is
starvation in other countries?
• On development: Is it ok to displace farmers in order to build big dams?
• More importantly, should Batman kill Joker to prevent further harm to Gotham City?
A CRUDE UTILITARIAN VS A COMMITTED
DEONTOLOGIST
 UTILITARIANISM
AND INEQUALITY
The inequality scenario has higher average
wealth, but higher dispersion and inequality.

What matters is not aggregate wealth, but welfare.

How is this distribution of wealth translating to
welfare?

This is where economic analysis can provide

some answers.
• Can use a function representing the total amount of welfare in the economy, aggregating
over individuals. This is the Social Welfare Function.
• The Utilitarian social welfare function thus incorporates three main aspects:
• 1. Since it focuses on welfare and well-being, the SWF depends on utilities of
individuals.
• 2. Since it depends on aggregate welfare, the SWF can be represented as a sum.
• 3. Since all individuals are equally worthy, every individual is weighted equally in the
SWF.
THE UTILITARIAN SOCIAL WELFARE FUNCTION
(SWF)
• The Utilitarian SWF is a simple sum of individual utilities.
• = + +…..+ .
• More generally, it is an example of a weighted-sum-of-utilities function:
• SWF = where is the weight given to each individual and is individual i’s utility. In
utilitarianism, all weights equal to 1.
• Consider two individuals, so = +
• The social indifference curve (isowelfare curve): Curve that shows constant social welfare
for differing combinations of individual 1 and 2’s utilities.
• What shape do you think it could be?
 UTILITARIAN SOCIAL
WELFARE CURVE
The utilitarian social welfare function is a straight
line. Since all utilities weighted equally, and the SWF
is a simple sum, the slope of this line (d/d) = -1.

If the SWF is a weighted sum: + what would the

isowelfare curve look like if:

i. >

ii. <
HOW IS INCOME DISTRIBUTED IN A
UTILITARIAN MODEL?
• Assume two individuals, A and B, their utility functions – and - depend on the amount
of income - and - display standard properties, including diminishing marginal utility.
• Social welfare is given by U = + .
• The important question: how must total income be distributed amongst these two
individuals to maximise social welfare? Formally:
• Maximise U subject to total income I =
• A simple model of constrained optimisation.
SOLVING…

• The Lagrangian: L = + + λ( I - - )
• = - λ = 0 ……….(1)
• = - λ = 0 ……….(2)
• Equating (1) and (2), we get condition: =
• In a utilitarian society, social welfare will be maximised when income is distributed such
that marginal utilities are equalised.
UTILITARIANISM AND REDISTRIBUTION

• Thus utilitarians not opposed to redistribution. If current pattern of inequality leads to

marginal utilities not being equalized, then it is ok to redistribute till marginal utilities are
made equal.
• Redistribution as an idea made possible by diminishing marginal utility. If marginal
utility was increasing, then utilitarianism would have to conclude that all in situation of
inequality, money would have to be redistributed to ones with more wealth and more
marginal utility.
• What are the redistributional implications of utilitarianism?
UTILITARIANISM AND EGALITARIANISM.

• If every individual’s utility function is the same, then if the question is how to redistribute
a given income, everyone should get the exact same amount!
• Let = and =
• = => (1/2). = (1/2). => =
• If I = + => = = 0.5I
• If a given amount of income has to be divided amongst individuals all with the same
utility function, then utilitarianism would say divide it equally.
• What if utility functions different?
• Assume = 2 and =
• = => = (1/2).
• In what proportions will income now be divided between A and B?
• Under a utilitarian social welfare function, the division of a given amount of income will
depend on the difference in utility functions.
UTILITARIANISM AND REDISTRIBUTION

• Imagine a society of two individuals A and B, and a utilitarian social welfare function.
Imagine a change to be made that raises only one individual’s utility by 100. (We are not
trying to maximise utility subject to a given income, but trying to see which person
should benefit from a given change.)
• Total welfare W = + . Question: who should benefit from this change?
• = = 1. Social welfare will increase regardless of who gets the increase in utility.
• Under utilitarianism, it doesn’t matter who gets the increased utility, since total welfare
depends only on the sum total of utilities.
• Imagine we have to decide on a policy that raises someone’s utility by 1000 units and
reduces someone’s utility by 1 unit. In a utilitarian framework, whose should be reduced
and whose should be increased?
• What about the following social welfare functions?
• i. W = .
• ii. W = 10 - -
CARDINAL AND ORDINAL

• Simple utilitarian functions are cardinal functions. This implies we can compare two
levels of utility for individuals. But Strong critique of interpersonal utility comparisons
by Lionel Robbins.
• Basic idea: what does it mean to say that the utility I get from eating ice cream is more
than the utility someone else gets from eating an apple? How does one compare different
subjective levels of utility?
• Motivated the need for ordinal functions. Functions which rank preferences, rather than
provide an exact measurement of them.
BASICS OF WELFARE ECONOMICS

• Amartya Sen characterized welfare economics as having the following characteristics:

• 1. Welfarism: Social welfare is a function of personal utility levels alone.
• 2. Ordinalism: Only ordinal utility functions to be used, not cardinal.
• 3. Noncomparable utilities: Cannot compare the utility levels of individuals.
• 4. Pareto preference rule: If everyone had at least as much utility in situation X
compared to situation Y, and someone had more utility in X than Y, X should be chosen.
• Some forms of ordinal functions are Samuleson-Bergson functions (SB). This is a
function that would evaluate the rankings of different states done by individuals, and
provide a measure of the best social state.
• Why should state X be ranked above state Y? Here, explicitly value judgements can be
brought in. Should it be based on utility? On something else?
• W = F(, ……… ). (Utilitarianism is a special function where W is simply the sum of
cardinal utilities. Here, it is a function of ordinal utilities.)
• Important condition: the utility functions used here should be the same as those the
consumer uses when maximising satisfaction from consuming goods.