Welfare Measurement in Imperfect Markets

Welfare Measurement in Imperfect Markets

A Growth Theoretical Approach

New Horizons in Environmental Economics series

Thomas Aronsson, Karl-Gustaf Löfgren and Kenneth Backlund

This book cleverly integrates the research on welfare measurement and social accounting in imperfect market economies. In their previously acclaimed volume, Welfare Measurement, Sustainability and Green National Accounting, the authors focused on the external effects associated with environmental damage and analysed their role in the context of social accounting. This book adopts a much broader perspective by analysing a wide spectrum of resource allocation problems of real-world market economies.

Chapter 3: A Money-Metrics Version of Weitzman’s Welfare Theorem

Thomas Aronsson, Karl-Gustaf Löfgren and Kenneth Backlund

Subjects: economics and finance, environmental economics, valuation, environment, environmental economics, valuation


Weitzman’s (1976) fundamental result on welfare measurement introduced in Chapter 2 was obtained in a first best setting with one aggregate consumption good, m capital goods, and a utility function equal to aggregate consumption. Hence, by normalizing the price of the consumption good to one, the Hamiltonian will coincide with real NNP and, consequently, the money and utility metrics will coincide. However, in a more general setting this is no longer true. Since utility is not observable, a practical problem arises, at least if we want an observable measure of the static welfare equivalent. We attempted to deal with this problem in Chapter 2 by linearizing the utility function as in equation (2.17b). In a first best setting, with no externalities and one consumption good, this would give us an approximate relation between current NNP and future wealth. However, the approximation will be poor if the utility function deviates strongly from linearity. In addition, more than one consumption good will give rise to a price index problem. To simplify as much as possible, and since Weitzman’s (1976) result constitutes a natural starting point, we carry out the analysis in a first best framework. As such, the most important result is Proposition 3.2, which provides a money-metric analogue to the first best welfare theorem in a utility metrics. It shows exactly what information is required for measuring welfare at a given point in time, as well as explaining why the traditional approach of linearizing the Hamiltonian might be misleading. 3.1 THE...

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