Welfare economics

Welfare economics looks at how economic policies affect society, families and the individual. Welfare economists are interested in measuring how fair our economic systems are. So they do this looking at how income and wealth are distributed among the population. They also investigate the effects of government policy on equity.

Governments fight inequity through taxation. Welfare economists try to find out how taxation affects vertical equity and horisontal equity. These are two ideas that taxation systems can be based on. The idea behind vertical equity is that people with more income will pay more than those with less income. The idea behind horizontal equity is that people with the same income will pay the same amount of tax. Ideally, a tax system will have both vertical and horizontal equity.

However, some economists feel that any kind of taxation is unjust. They believe it is unfair to penalise entrepreneurs and hard-workers. Why should they support people who are less able or less hard-working? Trying to create equity, they say, is just a waste of time as inequity is a natural feature of every economic system. Instead, it is better to make economic systems more efficient that help everyone in society benefit. 

Wellare economics is also about the impact that economic choices have on our lives. Economic transactions often affect other people who are not directly involved in those transactions. Economists call these results externalities. Externalities are sometimes good and sometimes bad for society. For example, pollution is a negative externality of the car industry. But cars give people better mobility, which is a positive externality of the same industry.

Now read the text again and answer these questions in your own words.

According to the text, what do people often forget about economics?

How do governments try to make the economy fair?

‘What is the difference between horizontal and vertical equity?

Why do some economists think equity is not important?

What are externalities?