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Edited by Ross B. Emmett
Chapter 5: The Chicago School of Welfare Economics
H. Spencer Banzhaf* Introduction Throughout the first half of the twentieth century, applied welfare economics of the type now used routinely in policy analysis was viewed by most Anglo-American economists to be a futile task. Even as government requirements for measures of the benefits of public projects grew in parallel with economists’ skills in econometrically measuring demand, economists avoided even simple measures of welfare. But during the 1950s and 1960s, across a broad spectrum of schools, economists slowly began to lose their reluctance. Operations research, which met economics at such institutions as RAND, Cowles and the Harvard Water Program, formulated problems around an empirical pay-off function to be maximized, which in turn gave rise to welfare measures. Agricultural economics, with its tradition of empirical estimation of demand curves, began to estimate demand for public goods such as outdoor recreation for purposes of benefit–cost analysis (Banzhaf 2005). And, during the same period, key members of the Chicago School of Economics like Milton Friedman, George Stigler and especially Arnold Harberger began to turn to applied welfare economics as well. Chicago, admittedly, seems an unlikely place for such a development. Representing the ‘old Chicago’, Frank Knight expressed the belief that on the one hand Marshallian demand curves, which do not hold utility constant, are not an appropriate tool for welfare measurement, while on the other hand Hicksian demands are a mere intellectual construct, unrelated to observable behavior and hence unmeasurable. Consequently, according to Knight, consumer surplus is a concept of ‘extremely little...
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