Alteridad e identidad

Economists are often faced with the task of evaluating the social welfare effects of alternative economic policies. It is necessary to both measure individual welfare and to make interpersonal comparisons of welfare in order to systematically assess and choose between projects or policies. In general, it is assumed that economic welfare is derived from the consumption of goods and that the quantities consumed are chosen to maximize utility subject to a budget constraint. Government policies are seen to alter relative prices and/or incomes and thus, to impact on utility maximizing consumptions and, hence, consumer welfare. The welfare economist's task is to measure these welfare changes.

How is welfare to be measured? Five important criteria for a welfare measure are identified and described in detail in G. McKenzie (1983): 1) An applied welfare indicator must allow for behavioral responses to

prices and income changes. In other words, it must order alternative price and income combinations consistently with the consumer's own preferences. 2) Simultaneously, a single interpersonally comparable measure is required for each individual. 3) In addition, it is

units. This is by no means a necessary attribute, but serves to make the measure easier to interpret and conceptualize. A) The fourth McKenzie

criterion requires that the preferences embodied in the metric be

revealed directly from the analysis of ordinary demand functions. 5) Finally, it must be possible to aggregate the individual gains and losses into a well-defined social welfare function which embodies the

researcher's or policy maker's ethical judgements and thus, enables identification of a preferred economic policy.

Note that the essential concern here is with large public policy programs which tend to have significant impact on consumer prices and incomes. A common alternative approach in cost benefit analysis assumes that policy changes involve infinitesimally small perturbations to

prices. In this case, first order analysis is appropriate. A linear approximation can then be taken to the indirect utility function around the original position. Unfortunately, first order indicators are

inadequate when policy changes are not small. The thesis considers only large policy changes for which higher order effects can be significant.

The idea of linking demand functions, preferences, and welfare

measurement led theorists starting with Dupuit (1844) and Marshall (1890) to the notion of consumer surplus. This refers to the monetary value of a change in welfare due to a change in consumption, prices and/or income. It is measured by the area under the Marshallian demand curve. As such it represents the integral of incremental benefits from each additional consumption unit valued at marginal willingness to pay. Primarily due to its intuitive appeal, consumer surplus has remained the cornerstone of applied approaches to welfare measurement. This tendency has not been without controversy. Criticisms of consigner surplus have been levelled

from early on by various economic theorists (including Marshall himself in the 1920 edition of The Principles)A

The fundamental problem with the Marshallian consumer surplus measure is that it ignores the income effects of price changes or, equivalently, assumes that the marginal utility of income is a constant, independent of prices and incomes.^ This implies that all income elasticities are zero which violates non-satiation, is fundamentally impossible, and is

furthermore, empirically rejected. Thus, since income effects are not zero, consumer surplus as measured by the area under the Marshallian demand curve is not a correct welfare measure.

The nature of the problems encountered with Marshallian consumer surplus measures, led theorists to turn to the Hicksian measures of

equivalent and compensating variation (EV and CV respectively). Derived from the compensated demand function along which utility is held

constant, these measure the difference in cost of attaining a given utility level at alternative price vectors.

The cost (or expenditure) function is defined as the minimum cost of achieving utility level u for a household with characteristics

represented by the vector z when facing the vector of prices p for all goods i = l,...,n. Thus,

c = c ( u, p , z ) (2.1)

The EV is defined as the lump-sum income necessary to keep the consumer indifferent to any new level of utility given original prices. Thus, in terms of the cost function.

EV = c(ul, pl.z) - c(ul, pO.z) (2.2)

where the superscripts o and 1 refer to the initial and new situations respectively. The CV is defined as the money compensation required for an initial level of utility to be maintained following a price change.

CV = c(uO, pl.z) - c(uO, pO,z) (2.3)

While the EV is always calculated with reference to the final utility level, the CV is derived with reference to a base level of satisfaction. For this reason, the measures are not in general equal.

It is, however, easy to choose between them. Only the EV is an ordinal welfare metric for multiple policy shifts. Since it employs the same (original) price vector to evaluate each price change, valid welfare comparisons of the money valued gains from any number of policy shifts are possible. In contrast, the CV which takes each new price vector as its reference, only allows binary comparisons (L. McKenzie, 1956; King, 1983; G. McKenzie, 1983).

The EV and CV thus present exact analogs to consumer surplus. Yet, until recently, they were considered too difficult to calculate due to the fact that compensated demand functions can not be directly observed. Instead, much effort has been spent perfecting measures derived from more readily available information on Marshallian demand curves. These have included various approximations based on consumer surplus along with conditions under which the associated errors will be small.^

Recent developments in the area of welfare measurement have focused on a methodology which, like traditional consumer surplus analysis, takes

as its starting point the parameters of ordinary demand functions. Duality methods are then used to retrieve information about either the underlying indirect utility or cost functions. This next enables calculation of the equivalent or compensating variations. Slight

modifications result in welfare metrics which are estimatable and accord well with the criteria set out by G. McKenzie (1983) and referred to

earlier. I now turn to these metrics of welfare.