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 5: Green Accounting and Distortionary Taxation

Thomas Aronsson, Karl-Gustaf Löfgren and Kenneth Backlund

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


The decentralized economy analyzed so far contains a single distortion: an external effect associated with environmental damage. Within such a framework, one of the main purposes of Chapter 2 was to derive exact welfare measures in an uncontrolled or imperfectly controlled market economy and compare them with the first best welfare measure. However, although market failures have important implications for welfare measurement, our previous analysis was based on the assumption that the first best can (in principle) be attained by means of a properly designed policy rule. This basic idea was further explored in Chapter 4, where we argued that such policy rules are difficult to implement in practice, which may necessitate a ‘practical approach’ to social accounting. On the other hand, if we were to relax the assumption that the government has the appropriate policy instruments for implementation of the first best, the concept of social optimum would also change. One example – thoroughly addressed in other areas of welfare economics – is that the public revenues have to be raised by distortionary taxes. This is clearly relevant for welfare measurement, since distortionary taxation gives rise to a welfare cost. In Section 5.1, we consider green accounting under distortionary taxes and explain why the green NNP in utility terms derived earlier may fail to measure welfare in this case, as well as derive a second best analogue to the green NNP in utility terms. Although the step from the first best to the second best resource allocation has practical value...

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