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Welfare Economics I: Pure Exchange In our study of public economics, we will take a particular approach. We will think of the government not as seeking to advance its own welfare (as many, if not most, governments have been historically and remain to this day), but rather as acting to achieve certain goals on behalf of households in the economy (the public).

In taking this simple (in some sense simplistic) view of government, we necessarily leave out a broad range of issues relating to the incentives and underlying interests of the individuals and economic institutions that actually work for the government. This is a significant omission; and while this approach is useful, it will be important to keep in mind always that this major abstraction has been made. In any case, we will proceed by taking first the premise that a market economy exists and functions, for better or worse, without whatever central authority there is doing anything but guarantee individual property rights and enforce private agreements where possible.


The results are some economic outcomes which may or may not be desirable from the point of view of some or all members of the population. We will then consider ways in which the government, through various public sector institutions can intervene in the economy to improve on these outcomes.

Then, we will consider how these interventions, all of which require resources, will be financed. First, however, we need a set of tools to determine which outcomes of the (possibly hypothetical) market economy sans government interventions are potentially undesirable and thus candidates for improvement. Welfare economics is concerned with developing such tools, and considering their applications.

Unlike much of economic theory, welfare economics is explicitly normative; and necessarily involves “value judgements”. As we will see, some of the normative concepts of welfare economics are mutually exclusive, and choices have to be made. Economic theory per se has little offer with regard to these choices, which are normally made through the political process. Rather, the role of welfare economics is to illuminate the detailed implications of the various feasible alternatives.