Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it. It analyzes social welfare, however measured, in terms of economic activities of the individuals that compose the theoretical society considered. Accordingly, individuals, with associated economic activities, are the basic units for aggregating to social welfare, whether of a group, a community, or a society, and there is no “social welfare” apart from the “welfare” associated with its individual units.
Welfare economics typically takes individual preferences as given and stipulates a welfare improvement in Pareto efficiency terms from social state A to social state B if at least one person prefers B and no one else opposes it. There is no requirement of a unique quantitative measure of the welfare improvement implied by this. Another aspect of welfare treats income/goods distribution, including equality, as a further dimension of welfare.
Social welfare refers to the overall welfare of society. With sufficiently strong assumptions, it can be specified as the summation of the welfare of all the individuals in the society. Welfare may be measured either cardinally in terms of “utils” or dollars, or measured ordinally in terms of Pareto efficiency. The cardinal method in “utils” is seldom used in pure theory today because of aggregation problems that make the meaning of the method doubtful, except on widely challenged underlying assumptions. In applied welfare economics, such as in cost-benefit analysis, money-value estimates are often used, particularly where income-distribution effects are factored into the analysis or seem unlikely to undercut the analysis.
Since the early 1980s economists have been interested in a number of new approaches and issues in welfare economics. The capabilities approach to welfare argues that what people are free to do or be should also be included in welfare assessments and the approach has been particularly influential in development policy circles where the emphasis on multi-dimensionality and freedom has shaped the evolution of the Human Development Index.
Economists have also been interested in using life satisfaction to measure what Daniel Kahneman and colleagues call experienced utility.
What follows, for the most part, therefore refers to a particular approach to welfare economics, possibly best referred to as ‘neo-classical’ or ‘traditional’ welfare economics.
Other classifying terms or problems in welfare economics include externalities, equity, justice, inequality, and altruism.