Welfare Economics
Study questions
The following questions are provided to assist your personal study and revision for
the exam. They are principally intended to provide a focus for your reading on the
module. Some of the questions would not really be suitable for an exam, but have
been written with the somewhat broader objective of provoking thought and
discussion. Nevertheless, the questions overall provide an indication of the ‘type’ of
questions to be included in the final exam. Some of the questions ‘overlap’ i.e. cover
the same subject matter or key knowledge.
You are welcome to submit written answers to these questions to me at any time for
feedback. I would also be happy to discuss any of these questions in class upon
request.
Also reproduced below (listed separately) are the questions included in the 2001,
2002 and 2003 exams for this module.
Reminder: the format for this year’s final exam for this module is, as in 2003: an
unseen exam; answer any 3 from 6 questions.
All the best,
Nancy Devlin
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1. What is welfare economics? In particular, (i) what
characterises and distinguishes welfare economics as a
branch of economics? And (ii) in what respects are the
methods of welfare economics a distinctively ‘economics’
(as opposed to a philosophical, political or ethical)
approach to the questions it seeks to address?
2. Explain the following concepts and, using an Edgeworth
box, clearly label points to demonstrate each of them.
(a) Weak Pareto improvement
(b) Strong Pareto improvement
(c) Pareto inferior
(d) Pareto superior
(e) Pareto optimal
(f) Pareto indifferent
(g) Pareto non-comparable
(h) Contract curve.
3. What is the Pareto principle, and what are its strengths and
limitations as a value judgement in social decision-making?
4. Draw an Edgeworth box to represent all possible (i.e.
unconstrained by income or market prices for the goods)
allocations of 2 goods between 2 consumers. Explain what
is meant by a ‘weak Pareto improvement’ and a ‘strong
Pareto improvement’ and use your diagram to demonstrate
each.
5. In an Edgeworth box showing all possible allocations of 2
inputs between 2 firms, label points which are, vis a vis
other points: Pareto superior, Pareto inferior, Pareto
indifferent, and Pareto non-comparable.
6. (a) Given a weekly income of $200 and market prices for
Good X of $20 and Good Y of $40, draw this household's
budget line. (b) For a set of hypothetical indifference
curves, show on your diagram and explain the household's
utility maximising consumption decision. (c) Show the
income and substitution effects resulting from a decrease
in the price of Good X, where Good X is an inferior good
for this household.
7. Explain what is meant by the following and what insights they contribute in
welfare economics:
(a) Consumer surplus
(b) Kaldor’s and Hicks’ compensation tests
(c) Utility possibility frontier
(d) Bergsonian social welfare function
(e) Arrow’s Impossibility Theorem
8. Distinguish between technical efficiency and economic
efficiency in production.
9. (a) Explain Rawls’ theory of social justice, and contrast this
to the Utilitarian view. What characteristics would the
Social Welfare Functions corresponding to each of these
perspectives have? (b) What is the principal critique of the
Rawlsian perspective on equity?
10. State algabraically, explain and demonstrate, using
appropriate diagrams, each of the three conditions for
Pareto optimality satisfied by a perfectly competitive
economy. What is the relevance and implications of the
First Fundamental Theorem of Welfare Economics for
social policy?
11. What is Kaldor’s compensation principle? How is it used
to resolve Pareto non-comparability? How is it different
from Hick's compensation principle? What problems and
objections might exist with a reliance on the compensation
principle as a basis for social choices?
12. Explain how each of the following manifestations of
imperfect competition would violate the conditions
required by the first fundamental theorem of welfare
economics.
(a) a price discriminating monopoly
(b) monopsony power by a firm in its purchase of capital inputs
(c) the presence of a not-for-profit firm.
13. Is there a tradeoff between equity and efficiency? Discuss.
14. (a) What is the relationship between the utility
possibility frontier, the grand utility possibility
frontier and the contract curve in a consumption
Edgeworth box? (b) What conditions hold at the
point of 'constrained economic bliss', and how might
such a point be established?
15. In Figure 1, the initial endowments of health for two
individuals is such that their respective expected future
QALYs are represented by point A. Health care services
are available such that points B, C or D are feasible from
current resources, and represent mutually exclusive
options. What value judgements might be invoked in order
to rank these states?
Figure 1.
Expected future
QALYs, person
2
b
c
a
d
Expected future
QALYs, person 1
16. State the assumptions and conclusions of Arrow’s
Impossibility Theorem, and provide an explanation both of
the result and its implications for social decision making.
17. (a) State the characteristics of a pure public good.
(b) The following payoff matrix shows the net benefits to
two people (Player 1 and Player 2) from either
cooperating or not cooperating in the provision of a public
good. Identify the strategies that each will adopt, and
explain the implications for the efficiency of private
markets.
Player 2
Cooperate
Player 1
Cooperate
£6
Not cooperate
£10
Not
cooperate
£6
-£5
£10
-£5 £0
£0
(c) How might a Government determine the efficient quantity of a public good
to provide?
18. Using appropriate diagrams in each case, show the effects
on allocative efficiency of a private market in which there
exists
(a) a positive external effect from consumption
(b) a negative external effect from production.
Critically assess the solutions to such external effects proposed by Pigou and
Coase respectively.
19. Explain the importance of the ‘median voter’ in a
majority-vote decision about public expenditure. Under what
circumstances will a majority voting equilibrium be Pareto
efficient?
20. With reference to Table 1 below, showing three alternative
taxation systems and their effect on the tax paid by each of
three equal-sized groups of the electorate, explain the
problems that might be encountered in establishing a majority
vote equilibrium.
Table 1.
% income
taxes:
Poor
Middle
rich
paid
in A
30
30
30
B
C
20
20
50
15
35
40
21. Suppose the Government introduced a subsidy on a
medicine that was previously purchased by consumers at the
full retail price.
(a) Use indifference curves and budget lines to demonstrate
the compensating variation (CV) and equivalent variation
(EV) associated with the benefit to consumers of this
policy.
(b) Show how the compensated demand curves associated
with this policy would be derived from the diagrams you
drew in (a), and identify in each case the area representing
the EV and CV.
(c) Explain the way in which the CV and EV respectively
provide a ‘money metric’ of the consumers’ changes in
utility.
22. Explain the difference between the following as monetary
measures of welfare change: consumer surplus;
compensating variation; equivalent variation.
23.
(a)
Given that a household has a weekly income of £100, and faces
market prices for Good X of £20 and Good Y of £10, draw this
household's budget line. For a set of hypothetical indifference curves,
show on your diagram and explain the household's utility maximising
consumption decision.
(b)
Show the income and substitution effects resulting from a
decrease in the price of Good X.
(c)
Show, for the prices and quantities indicated in your diagram,
the corresponding Marshallian and Hicks demand curves for Good X.
(d)
Demonstrate, using indifference curve and line diagrams,
Hicks’ equivalent and compensating variations for the ‘gain’ to the
consumer arising from the reduction in price.
24.
(a) Outline the critiques of welfarism made by Sen and
others.
(c) Mooney (2002) argues that “Sen is not extra
welfarist; his is non-welfarist”. Explain what
Mooney means by this statement.
(d) To what extent does Culyer’s extra welfarist
paradigm overcome the criticisms of welfarism?
25. Distinguish between welfarism, extra welfarism and
communitarianism as alternative paradigms underpinning the
economic evaluation in health care.
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Questions from the 2001 final examination:
1. Using diagrams to illustrate your answer, describe and explain the conditions under
which economic efficiency in an exchange economy is achieved.
2. Explain how the hypothetical compensation principles proposed by Kaldor and
Hicks may be used to address the problem of Pareto non-comparability. What are the
problems associated with their use?
3. Describe and explain the different social welfare ordering possibilities that are
feasible when utilities are non-comparable across households.
4. Explain how majority voting may be used as a means of revealing and aggregating
preferences of households. What are the problems associated with the majority voting
equilibrium?
5. Using health care as an example, explain how markets fail due to different types of
externalities arising from jointness in consumption and production.
6. Using diagrams to illustrate your answer, describe the methods by which a change
in health (both an improvement and a deterioration) may be measured in monetary
terms.
7. Explain why and under what conditions, when mutually exclusive projects are
being compared, the NPV decision rule should be used in preference to the IRR
decision rule.
8. Explain what is meant by any four of the following and why they are important to
the analysis of welfare economics:
(a) the Pareto principle
(b) Marginal rate of technical substitution
(c) Generalised utilitarian social welfare function
(d) The Lindahl equilibrium
(e) Social cost-benefit analysis
(f) Ordinal scale measurability.
Questions from the 2002 final exam:
1. Using diagrams, describe and explain the solution to the utility maximisation
problem faced by consumers. Demonstrate how you would represent changes in a
consumer's income and changes in the price of a normal good.
2. Using diagrams to illustrate your answer, describe and explain the conditions under
which an efficient allocation of the factors of production is achieved.
3. Under what conditions can households' preferences be aggregated? What are the
practical implications for social decision-making when these conditions are not met?
4. Describe and explain the different social welfare ordering possibilities that are
feasible when utilities are measurable on a ratio scale by households.
5. Describe and explain the conditions under which the provision of public goods is
efficient.
6. Using examples to illustrate your answer explain why government intervention in
the public provision of goods and services may be undesirable.
7. Using both the compensating variation and the equivalent variation explain how an
improvement in health may be valued in monetary terms. Describe and explain the
problems that may be encountered in using the contingent valuation method to elicit
these values.
8. Explain how cost-benefit analysis and cost-effectiveness analysis may be used to
rank social states. Discuss the assumptions involved.
Questions from the 2003 final exam:
1. (a) Provide a brief explanation of each of the following: weak Pareto
improvement; strong Pareto improvement; Pareto optimality.
(b) What are the limitations of the Pareto principle in attempts to achieve a social
welfare ordering? (c) Explain the role of social welfare functions in
overcoming the limitations discussed in (b).
2. State, explain and demonstrate, using appropriate diagrams, the First Fundamental
Theorem of Welfare Economics. What is the relevance and implications of this
Theorem for social choices?
3. (a) What are the characteristics of a pure public good? (b) This part of the question
was identical to study question 15(b) shown above (c) How might the Government
determine the efficient amount of a public good to provide?
4. Provide a detailed explanation of the role of the median voter in majority-vote
decisions about public expenditure. Under what circumstances will a majority voting
equilibrium be Pareto efficient?
5. Explain, using diagrams to illustrate, the difference between the following
monetary measures of welfare change: consumer surplus; compensating variation;
equivalent variation.
6. Explain the principal critiques of the welfarist approach to social choices. To what
extent do alternative paradigms, such as extra welfarism and communitarianism,
overcome these?