Chapter Thirty-One

Welfare
 Social Welfare Functions
 1. If all individuals’ preferences are
complete, reflexive and transitive,
then so should be the social
preference created by the voting rule.
 2. If all individuals rank x before y
then so should the voting rule.
 3. Social preference between x and y
should depend on individuals’
preferences between x and y only.
 Social Welfare Functions
 1. If all individuals’ preferences are
complete, reflexive and transitive,
then so should be the social
preference created by the voting rule.
 2. If all individuals rank x before y
then so should the voting rule.
 3. Social preference between x and y
should depend on individuals’
preferences between x and y only.
Give up which one of these?
 Social Welfare Functions
 1. If all individuals’ preferences are
complete, reflexive and transitive,
then so should be the social
preference created by the voting rule.
 2. If all individuals rank x before y
then so should the voting rule.
 3. Social preference between x and y
should depend on individuals’
preferences between x and y only.
Give up which one of these?
 Social Welfare Functions
 1. If all individuals’ preferences are
complete, reflexive and transitive,
then so should be the social
preference created by the voting
rule.
 2. If all individuals rank x before y
then so should the voting rule.
There is a variety of voting procedures
with both properties 1 and 2.
 Social Welfare Functions
 ui(x) is individual i’s utility from
overall allocation x.
 Social Welfare Functions
 ui(x) is individual i’s utility from
overall allocation x.
n
 Utilitarian: W   ui ( x ).
i 1
 Social Welfare Functions
 ui(x) is individual i’s utility from
overall allocation x.
n
 Utilitarian: W   ui ( x ).
i 1
 Weighted-sum: n
W   ai ui ( x ) with each ai  0.
i 1
 Social Welfare Functions
 ui(x) is individual i’s utility from
overall allocation x.
n
 Utilitarian: W   ui ( x ).
i 1
 Weighted-sum: n
W   ai ui ( x ) with each ai  0.
i 1
 Minimax:
W  min{ u1 ( x ), , un ( x )}.
 Social Welfare Functions
 Suppose social welfare depends only
on individuals’ own allocations,
instead of overall allocations.
 I.e. individual utility is ui(xi), rather
than ui(x).
 Then social welfare is
W  f ( u1 ( x1 ), , un ( xn ))
where f is an increasing function.
 Social Optima & Efficiency
 Any social optimal allocation must be
Pareto optimal.
 Why?
 Social Optima & Efficiency
 Any social optimal allocation must be
Pareto optimal.
 Why?
 If not, then somebody’s utility can be
increased without reducing anyone
else’s utility; i.e.
social suboptimality  inefficiency.
 Utility Possibilities
uB
OB

0
0 uA

OA
 Utility Possibilities
uA
uB
OB

0
0 uA uA

OA
 Utility Possibilities
uA
uB

OB uB

0
0 uA uA

OA
uB
 Utility Possibilities
uA
uB

OB uB

uB

uA 0
0 uA uA uA
uB
OA
uB
 Utility Possibilities
uA
uB

OB uB
uB
uB
uB
uA 0
0 uA uA uA
uB
OA
uB
 Utility Possibilities
uA
uB

OB uB
uB
uB
uB
uA 0
0 uA uA uA
uB
OA
uB
 Utility Possibilities
uA Utility possibility
uB frontier (upf)

OB uB
uB

uA 0
0 uA uA
uB
OA
uB
 Utility Possibilities
uA Utility possibility
uB frontier (upf)

OB uB
uB

uA 0
0 uA uA
uB
OA Utility possibility set
uB
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.

uA
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.

Social
indifference
curves
uA
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.
Higher social welfare

Social
indifference
curves
uA
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.
Higher social welfare

Social
indifference
curves
uA
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.
Social optimum

Social
indifference
curves
uA
 Social Optima & Efficiency
uB Upf is the set of efficient
utility pairs.
Social optimum is efficient.

Social
indifference
curves
uA
 Fair Allocations
 Some Pareto efficient allocations are
“unfair”.
 E.g. one consumer eats everything is
efficient, but “unfair”.
 Can competitive markets guarantee
that a “fair” allocation can be
achieved?
 Fair Allocations
 If agent A prefers agent B’s
allocation to his own, then agent A
envies agent B.
 An allocation is fair if it is
– Pareto efficient
– envy free (equitable).
 Fair Allocations
 Must equal endowments create fair
allocations?
 Fair Allocations
 Must equal endowments create fair
allocations?
 No. Why not?
 Fair Allocations
 3 agents, same endowments.
 Agents A and B have the same
preferences. Agent C does not.
 Agents B and C trade  agent B
achieves a more preferred bundle.
 Therefore agent A must envy agent B
 unfair allocation.
 Fair Allocations
 2 agents, same endowments.
 Now trade is conducted in
competitive markets.
 Must the post-trade allocation be
fair?
 Fair Allocations
 2 agents, same endowments.
 Now trade is conducted in
competitive markets.
 Must the post-trade allocation be
fair?
 Yes. Why?
 Fair Allocations
 Endowment of each is ( 1 ,  2 ).
 Post-trade bundles are
A A B B
( x1 , x2 ) and ( x1 , x2 ).
 Fair Allocations
 Endowment of each is ( 1 ,  2 ).
 Post-trade bundles are
A A B B
( x1 , x2 ) and ( x1 , x2 ).
A A
 Then p1 x1  p2 x2  p1 1  p2 2

and p1 x1B  p2 x2B  p1 1  p2 2 .

 Fair Allocations
 Suppose agent A envies agent B.
 I.e.
( x1B , x2B ) A ( x1A , x2A ).
 Fair Allocations
 Suppose agent A envies agent B.
 I.e.
( x1B , x2B ) A ( x1A , x2A ).
 Then, for agent A,
B B A B
p1x1  p2 x2  p1 x1  p2 x2
 p1 1  p2 2 .
 Fair Allocations
 Suppose agent A envies agent B.
 I.e.
( x1B , x2B ) A ( x1A , x2A ).
 Then, for agent A,

B B A B
p1x1  p2 x2  p1 x1  p2 x2
 Contradiction.
 pis1not p2 2 .
1  affordable
for agent A. B B
( x1 , x2 )
 Fair Allocations
 This proves: If every agent’s
endowment is identical, then trading
in competitive markets results in a
fair allocation.
 Fair Allocations
1 OB

2 2

OA 1
Equal endowments.
 Fair Allocations
1 OB
Given prices
Slope p1 and p2.
= -p1/p2
2 2

OA 1
 Fair Allocations
1 OB
Given prices
Slope p1 and p2.
= -p1/p2
2 2

OA 1
 Fair Allocations
1 OB
Given prices
Slope p1 and p2.
= -p1/p2
2 2

OA 1
 Fair Allocations
1 OB

2 2
Post-trade
allocation --
is it fair?
OA 1
 Fair Allocations
1 OB
Swap A’s and
B’s post-trade
allocations
2 2
Post-trade
allocation --
is it fair?
OA 1
 Fair Allocations
1 OB
Swap A’s and
B’s post-trade
allocations
2 2
Post-trade
allocation --
is it fair?
OA 1
A does not envy B’s post-trade allocation.
B does not envy A’s post-trade allocation.
 Fair Allocations
1 OB
Swap A’s and
B’s post-trade
allocations
2 2
Post-trade
allocation --
is it fair?
OA 1
Post-trade allocation is Pareto-efficient and
envy-free; hence it is fair.