Chapter 5: Welfare Measurement and Public Goods in a Second-best Economy
Thomas Aronsson 1 INTRODUCTION Earlier chapters of this Handbook have either addressed first-best resource allocations, or resource allocations that – for one reason or another – are suboptimal from society’s point of view, in which case society as a whole has not made an optimal choice given its preferences and constraints. A basic message was that the current value Hamiltonian underlying the economic system constitutes an exact welfare measure in utility terms if the resource allocation is first best, whereas it does not in general constitute an exact welfare measure if the resource allocation is suboptimal.1 One purpose of the present chapter is to address the welfare measurement problem in an economy where the first best is unattainable due to the necessity to raise public revenue by means of distortionary taxes. In such a second-best economy, the government (or social planner) has made an optimal policy choice, although the set of policy instruments might not be flexible enough to implement the first best. Another purpose is to address the treatment of public consumption in the context of social accounting. I will also briefly address redistribution, which is another important aspect of public policy. Why are taxation, public consumption and redistribution interesting to analyze in the context of welfare measurement and social accounting? First, the public sector plays a crucial role for the allocation of resources in all developed countries by providing public services as well as by redistributing income among individuals and groups. As a consequence, public expenditure is likely to be...
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