Social benefit, Cost and welfare

function

Ramindra Suwal
Roll No.:R-2018-AEC-15M
 Social Cost benefit Analysis
• A systematic evaluation technique for long-
term decision making in capital projects
appraisal.
• an analytical tool in decision making
• a systematic comparison between the social
costs and related social benefits with due
emphasis on technical and other feasibility
studies but focusing more on social impact.
 Social cost
• Sum of the private cost and the External cost
resulting from the activity.

• The difference between social cost and

private cost is important, as the private cost
may over- or underestimate the true cost of
an activity.
 Examples of social costs

• Air pollution
• Water pollution
• Depletion and destruction of animal resource
• Soil Erosion
• Deforestation
• Impairment of human resources
• Deterioration in the law and order conditions
 Categories of Social Cost.
• 1. Social costs of Staff:
a. Lay off and voluntary termination
b. Extra hours put in by officers voluntarily
c. Work-related injuries
d. Undesired attitude formation

• 2. Social costs of Community and General public:

a. Increase in cost of living in the vicinity due to cement plants
b. Consumption of state electricity services
c. Central services and facilities consumed
d. State services and facilities consumed
e. Expenditure in foreign in foreign exchange
f. Environmental damage
g. Product shortcomings
 Social Benefits:
• The total benefit from any activity.
• benefits accruing directly to the person or firm
conducting the activity,
• Also includes external benefits accruing to other
people who cannot be charged for them.
• an increase in the overall welfare of the community
or society which is being derived from a particular
course of action by a business firm or government
other than the person who is receiving the benefit.
• For example Society gets benefitted from public
parks developed and maintained by government.
• Social benefit = private benefits + any external
benefits (external benefit is cost or benefit that
affects a party who did not choose to incur that
cost or benefit) of production / consumption.
• If a good has significant external benefits, then
the social benefit will be greater than the private
benefit.
• social benefits may be in the form of products
and services provided, payment of taxes and
rates, additional employee’s benefits, donations
to the community, environmental improvements,
etc.
 Categories of Social Benefits
• 1. Social benefits of Staff:
a. Medical and hospital facilities
b. Educational facilities
c. Subsidized canteen facilities
d. Provident fund
e. Housing and township facilities
f. Holiday, leave encashment and leave travel benefits.
g. Recreational and cultural facilities

• 2. Social benefits of Community and General public:

a. Local taxes paid to Municipality
b. Environmental improvements
c. Generation of job potential
d. Welfare activity for the community
e. Business generation
 The Relationship Between Private
Profitability and Net Social Benefit

• Net social Benefit = Social Benefit for Direct

Effects + Net Effect of Externalities

• Net Social Benefit = Private Profitability +

Gross Social Benefits + Gross Social Costs -
Net Costs of Externalities
• In nutshell, social costs and benefits are
concerned with measurement of impact
of the project on society, which may be
positive or negative.
• The positive impact is social benefit and
negative impact is social cost.
• In fact when we evaluate a project from
the point of view of the society (or
economy) as a whole, it is called Social
Cost Benefit Analysis.
 Social welfare function:
• welfare of society to the utility levels of individuals and is
used in evaluating the effects of changes in the quality or
quantity of environmental goods.
• Johansson (1987) notes that this welfare function is
generally assumed to have three major properties.
• First, an increase in the utility of one individual, when the
utility of all other individuals remains constant, increases
social welfare.
• Second, if there is a reduction in the utility of one
individual, there must be an increase in the utility
experienced by another for social welfare to remain
constant.
• Third, the weight given to the welfare of an individual is
linked to his or her utility level – that is, weights can be
applied to account for distributional considerations.
• A social welfare function is necessary to
identify the optimal resource allocation
from among the Pareto-efficient allocations.
• That allocation of a society’s resources,
pattern of production and distribution of
output which is the 'best' attainable
according to some stated set of objectives.
• In the diagram below, we
have a two-person
community. The line u-u
represents, in terms of each
individual's UTILITY or well-
being the various,
alternative Pareto optimal
points possible while the w-
w lines represent
combinations of individual
utility which give rise to
equal levels of social
welfare. Higher w-w lines
indicate higher levels of
social welfare. The point S is
the highest attainable level
of social welfare and thus is
the social optimum.
 DIFFERENT CONCEPT AND MEASUREMENT
CRITERION OF SOCIAL WELFARE

• 1) Growth of GNP as a criterion of welfare:

economic growth results the increase of social
welfare because growth increased
employment and the goods available for
consumption to the community. This criterion
highlights the importance of efficiency in
social welfare.
 2) Bentham’s criterion

This criterion assumes that the total welfare is the

sum of the utilities of the individual of the
society. Let A, B, C are the individuals of a society.
So,
W = UA + UB + UC
According to Bentam, WΔ > 0, if Δ UA+ Δ UB + Δ UC
> 0.
Suppose A and B’s utilities are increased with
decreased C’s utility, but Δ UA+ Δ UB > Δ UC.
Here, two individuals A and B are better off while
C is worse-off after the change have taken place.
 3) Cardinalist Criterion

• 3) Cardinalist Criterion
• based on diminishing law of marginal
utility.
• welfare can be maximized if income is
equally distributed among all members
of the society.
 4) Bergson’s Social Welfare Criterion

• based on explicit value judgment which enables

the analyst to evaluate the situation.
• According to Bergson, the value judgment may be
explicitly formed in the form of a social welfare
function.
• A social welfare function is an indifference map
which ranks different combinations of individual
utility according to a set of explicit value
judgment about the distribution of income.
• Social welfare function is similar to the utility
function of a consumer.
• social welfare function is an
ordinal index of welfare of the
society and is a function of the
utility levels of all individual
members.
• W = f (U1, U2, ………….,Un)
• where, W = Social welfare
• U1, U2, ………….,Un =
Utility index of an individual .
• Suppose there are two
persons, A and B in an
economy. Their social welfare
function can be written as
• W = F (UA, UB)
 5) Kaldor-Hicks Compensation
Criterion
• “if gainers of a proposed economic change
evaluate their gains as G and losers evaluate
their losses as L, and if G>L, then gainers
would be able to compensate the losers and
yet retain a net gain. Under this condition, the
proposed change will increase the social
welfare.
Here, MR = MK + KR , and MK is sufficient to compensate B
because MK= JM. A is left with net gain of KR after
compensating B for the loss. This indicates an improvement in
social welfare.
 6) The Pareto-optimality Criterion

• According to Pareto criterion, any change

that makes at least one person better-off
without making someone else worse-off
makes definitely an improvement in
social welfare.
• Conversely, any change that makes at
least one person worse-off and no one
better-off causes a decrease in the social
welfare.
• Following marginal conditions must be
satisfied:
1. Efficiency of distribution of commodities
among consumers (efficiency in exchange)
2.Efficiency of the allocation of factors among
firms/producers (Efficiency of production)
3.Efficiency in the allocation of factors among
commodities (efficiency in the product-
mix/composition of output)
• 7) The theory of Second Best
• by Richard G. Lipsey and Kelvin Lancaster,
• When one or more of the first order
conditions of Pareto optimality are not
fulfilled for some reasons, the remaining
conditions can be satisfied to have a solution
as close as possible to the Pareto optimality.
This is known as theory of second best. The
greater the number of conditions of satisfied,
the closer would be the solution to Pareto
optimality.
Thank
you