Welfare Economics

Welfare Economics

In a mixed economy, the government and the market forces work together to ensure optimal allocation of resources that may help to maximize social welfare as well as corporate profits. Under welfare economics, the government is expected to play an effective role and regulate profits so that the society, as a whole, benefits the most and the gap between the rich and the poor declines.

Monopoly, as a form of market, is a price maker and has the capability of capturing the entire consumer surplus. Hence, to stop the consumers from getting exploited, the government intervenes, regulates and monitors the firm. It checks the price instability and supply of the good in the market. Hence, the monopolist is not allowed to exploit the masses.

One way to regulate a monopoly is to define its marginal cost accurately. The government sets the price of the product the monopoly produces equal to its marginal cost or average cost. In case of the former, since the marginal cost is lower than the average cost, the firm suffers a loss. Hence, the firm might not agree to this particular kind of regulation unless the government offers it a subsidy so as to cover at least its average cost. A better way is price discrimination. The firm charges high price from a set of its relatively rich customers while uses marginal cost pricing for the marginal section of the society. The profits made by selling the good to the intra-marginal users offset the losses incurred by selling to others. This is one of the most convenient ways to achieve social welfare and economic prosperity at the same time. Yet another way to tackle the issue is to define a ‘fair’ rate of return for the monopoly firm which it cannot exceed, regardless of the price charged by the firm. Here, the complication is to calculate the ‘fair’ rate.

Although limited but the importance of welfare economics in India has been realized recently, one example of which has been cited above. Researches in fields that involve huge finance and the ones that are highly risky, for instance, nuclear science, must be carried using welfare economics so that its cost and   risks are minimized.

 

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