Pigou

Pigou’s welfare economics
Arthur Cecil Pigou succeeded Prof. Marshall as the Professor of Economics at the
University of Cambridge. After Marshall, he became the leading neo classical economist.
He is the founder of “Welfare Economics” His leading ideas on welfare economics are
found in his “Economics of Welfare” (1920). Prof. Pigou popularized the word welfare and
gave a concrete meaning to it.
In his book, Pigou dealt with three things: (1) A definition of economic welfare (2)
Spelling out the condition under which welfare is maximized and (3) Pronouncement of
policy recommendations for increasing welfare.
Definition of economic welfare
He defined individual welfare as the sum of satisfactions obtained from the use of goods
and services. He defined economic welfare as that part of social welfare “that can be
brought directly or indirectly into relation with the measuring rod of money.”
Pigovian Welfare Conditions:- Pigou regards economic welfare and national income as
coordinate. He lays down two conditions for maximizations of welfare:
(i) Given the taste and income distribution, an increase in national income represents an
increase in welfare, (ii) For welfare maximisation, the distribution of national income is
equally important. If national income remains constant, transfer of income from rich to
the poor would improve welfare. With income subject to diminishing marginal utility,
transfers of income from the rich to the poor will increase social welfare by satisfying the
more intense wants of the poor. Thus it is economic equality that maximizes welfare.
Dual criterian:- To find out improvements in social welfare, Pigou adopts a dual criterion:-
1 Pigou suggest that in order to increase the national income production of some goods
must be increased without reducing the production of other goods. 2 reorganization of the
economy in such a way that share of poor people in the reorganized economy must be
higher without reducing the national income.
Private and cocial cost :- Pigou has made a distinction between private and social
costs. The private marginal cost of a commodity is the cost of producing an additional unit.
The social marginal cost is the expense or damage to society as a consequence of producing
that commodity. Private marginal benefit can be measured by the selling price of the
commodity.
Social marginal benefit refers to the total benefit that society gets from the production of
an additional unit. By making a distinction between social and private valuations of
economic activity, he paved the way for the analysis of external effects or externalities in
social welfare economics.
The presence of external effects in production was seen by Prof. Pigou in the divergence
between social net product and private net product. He defined social net product “as the
aggregate contribution made to the national dividend” and the private net product as the
contribution which is capable of being sold and the proceeds added to the earnings of the
person responsible for investment.
The divergence between the two products shows itself in the form of external effects of
production associated with marginal increments of output. In some cases social net
product is more than the private product while in others private product is greater than
the social product. As an example of the former, Pigou pointed out to the greater social
benefit from technical training of workers by a private firm.
As an illustration of the latter he cited the fact that the smoke rising from the chimneys of
private factory spoils the atmosphere of the locality and increases the laundry bills of the
people of the neighbourhood. But people are not compensated in any way by the factory
owner.
He was of the opinion that the state should equalize the private net product with social net
product, if in an industry where private net product is more, it should be taxed, and if
another industry shows a lesser private net product, it ought to be subsidized. Of course,
Prof. Pigou recognised that the divergence between private net product and social net
product cannot always be quantified and measured in terms of money.
Prof. Pigou made the first attempt to lay down the conditions of social optimum which he
termed “the ideal output” of the economic system as a whole. In his view, the social
optimum prevails when marginal social products are equal in all industries and thus
production of real wealth is maximised.
Assuming that all the productive resources are being employed and that there is no cost of
movement between different occupations and places, it can be concluded that the national
dividend is the largest when the values of the marginal social net products are equal in all
industries. If this arrangement prevails, the society is having its” ideal output”.
Assumptions of Pigovian Conditions: The Pigovian welfare conditions and the dual
criterion pre-suppose the existence of the following assumptions: (1) Each individual
tries to maximise his satisfaction from his expenditure on different goods and services.
2. Pigou believed that utility is not measurable cardinally. But inter personal and intra
personal comparisons of utilities are also possible so that it is possible to find out
quantitatively whether welfare has increased or decreased. (3) The law of diminishing
marginal utility of income applies. It means that the marginal utility of income falls, as
income increases. As a result, the gain in utility of an additional amount of income to a
poor man is greater than the loss of utility to a rich man from the same amount of income.
(4) There is equal capacity for satisfaction. It implies that different people derive the same
satisfaction out of the same real income. Given these assumptions, it is possible to satisfy
the Pigovian conditions of maximum social welfare on the basis of his dual criterion.
Its Criticism:- Though, Pigou’s Economics of Welfare is the first clear analysis of welfare
economics, yet the Pigovian ‘conditions of welfare’ have been criticised on the following
grounds: (1) The Notion of Maximisation is not clear: Pigou lays emphasis on the
maximisation of welfare, but he does not clarify the notion of maximisation. His
‘maximum’ is in fact the ‘optimum’, but it is a stable point. But this is not a correct view
because the ‘optimum’ is not stable. It changes with the increase or decrease of national
income. (2) Pigou measures ‘welfare’ cardinally: According to Pigou, welfare is measured
in terms of utility or satisfaction. He regards social welfare as the summation of utilities of
exchangeable goods and services to individuals. Economists do not agree with this view
because quantitative measurement of utility is not possible. It is for this reason that
modern economist’s measure utility ordinally.
(3) National Income is not an Accurate Measure of Welfare: Pigou’s welfare conditions are
related to the national income. But it is not easy to calculate national income. Again, social
welfare does not increase by a mere increase in national income. It is possible that national
income may increase due to inflationary rise in prices and the poor may become worse-off
than before. It is due to these reasons that modern economists measure welfare on the
basis of ‘choice’ rather than by national income. For instance, when an individual chooses
bundle A of some good rather than bundle 5, he undoubtedly derives greater satisfaction or
utility from A. It is in this way that his welfare increases.
(4) According to Professor Robbins, Pigou’s assumption of man’s equal capacity for
satisfaction does not make his notion of welfare a positive study. In his words, “This
assumption rests on ethical principle rather than upon scientific demonstration; it is not a
judgement of value.”
(5) Pigou does not clarify the ethical relation of welfare: Welfare economics is closely
related to ethics but Pigou does not clarify it. Welfare economics is essentially a normative
study in which value judgements and interpersonal comparisons are made. By not relating
these concepts with his notion of welfare, Pigou s economics of welfare is not considered as
an objective study of the causes of welfare.
Conclusion: These drawbacks in the Pigovian analysis have led modern economists to
expound the ‘compensation principle’ and the ‘social welfare function’ which are attempts
at giving a new tinge to welfare economics.

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