Relationship between National income and Economic Welfare

18/01/2021 0 By indiafreenotes

Economic Welfare

Before knowing the relation between economic welfare and national income, it is essential to define economic welfare. ‘Welfare’ is a state of the mind which reflects human happiness and satisfaction. In actuality, welfare is a happy state of human mind.

Pigou regards individual welfare as the sum total of all satisfactions experienced by an individual and social welfare as the sum total of individual welfares. He divides welfare into economic welfare and non-economic welfare. Economic Welfare is that part of social welfare which can directly or indirectly be measured in money.

Pigou attaches great importance to economic welfare because welfare is a very wide term. In his words: “The range of our enquiry becomes restricted to that part of social(general) welfare that can be brought directly or indirectly into relation with the measuring rod of money.’” On the contrary, non-economic welfare is that part of social welfare which cannot be measured in money, for instance moral welfare.

But it is not proper to differentiate between economic and non-economic welfare on the basis of money. Pigou also accepts it. According to him, non-economic welfare can be improved upon in two ways. First, by the income-earning method. Longer hours of working and unfavourable conditions will affect economic welfare adversely. Second, by the income-spending method.

It is assumed in economic welfare that expenditures incurred on different consumption goods provide the same amount of satisfaction. But in actuality it is not so, because when the utility of purchased goods starts diminishing the non-economic welfare declines which results in reducing the total welfare. But Pigou is of the view that it is not possible to calculate such effects, because non-economic welfare cannot be measured in terms of money.

The economist should, therefore, proceed with the assumption that the effect of economic causes on economic welfare applies also to total welfare. Hence, Pigou arrives at the conclusion that the increase in economic welfare results in the increase of total welfare and vice versa.

But it is not possible always, because the causes that lead to an increase in economic welfare may also reduce non-economic welfare. The increase in total welfare may, therefore, be less than anticipated. For instance, with the increase in income, both the economic welfare and total welfare increase and vice versa.

But economic welfare depends not only on the amount of income but also on the methods of earning and spending it. When the workers earn more by working in factories but reside in slums and vitiated atmosphere, the total welfare cannot be said to have increased, even though the economic welfare might have increased.

To obtain MEW, GNP totals are adjusted by:

(1) Reclassifi­cation of GNP expenditure into C, I and intermediate production, where only C contributes to current economic welfare,

(2) Imputations of the value of services of consumer capital, the value of leisure and the value of household work, and

(3) A negative correction for some of the dis-amenities of urbanization. Paul Samuelson called it net economic welfare.

Relationship

The effect of national income can be studied in two ways.

  1. Change in the size of National Income
  2. Changes in Distribution of National Income

Change in the Size of National Income:

The change in the size of national income may be positive or negative. The positive change in the national income increases its volume. As a result, people consume more of goods and services, which lead to increase in the economic welfare.

Whereas the negative change in national income results in reduction of its volume. People get lesser goods and services for consumption which leads to decrease in economic welfare. But this relationship depends on a number of factors.

  1. Change in Prices:

Is the change in national income real or monetary? If the change in national income is due to change in prices, it will be difficult to measure the real change in economic welfare. For example, when the national income increases as a result of increase in prices, the increase in economic welfare is not possible because it is probable that the output of goods and services may not have increased. It is more likely that the economic welfare would decline as a result of increase in prices. It is only the real increase in national income that increases economic welfare.

  1. Per Capita Income:

National income cannot be a reliable index of economic welfare, if per capita income is not kept in mind. It is possible that with the increase in national income, the population may increase at the same pace and thus the per capita income may not increase at all.

In such a situation, the increase in national income will not result in increase in economic welfare. But from this, it should not be concluded that the increase in national income results in increase in economic welfare and vice versa.

It is possible that as a result of increase in national income, the per capita income might have risen. But if the national income has increased due to the production of capital goods and there is shortage of consumption goods on account of decrease in their output, the economic welfare will not increase even if the national income and per capita income rise.

This is because the economic welfare of people depends not on capital goods but on consumption goods used by them. Similarly, when the national income and the per capita income rise sharply during war time, the economic welfare does not increase because during war days the entire production capacity of the country is engaged in producing war material and there is shortage of consumption goods. As a result, the standard of living of the people fall and the economic welfare decreases.

Often, even with the increase in national income and per capita income the economic welfare decreases. This is the case when as a result of the increase in national income, income of the richer sections of the society increases and the poor do not gain at all from it. In other words, the rich become richer and the poor become poorer. Thus, when the economic welfare of the rich increases and that of the poor decreases, the total economic welfare decreases.

  1. Working Conditions:

It depends on the manner in which the increase in national income comes about. The economic welfare cannot be said to have increased, if the increase in national income is due to exploitation of labour e.g., increase in production by workers working for longer hours, by paying them lesser wages than the minimum. Forcing them to put their women and children to work, by not providing them with facilities of transport to and from the factories and of residence, and their residing in slums.

  1. Method of Spending:

The influence of increase in national income on economic welfare depends also on the method of spending adopted by the people. If with the increase in income, people spend on such necessities and facilities as milk, ghee, eggs, fans, etc. which increase efficiency, the economic welfare will increase.

But on the contrary, the expenditure on drinking, gambling etc. will result in decreasing the economic welfare. As a matter of fact, the increase or decrease in economic welfare as a result of increase in national income depends on changes in the tastes of people. If the change in fashions and tastes takes place in the direction of the consumption of better goods, the economic welfare increases.

Changes in Distribution of National Income:

  1. Transfer of Wealth from the Rich to the Poor:

The redistribution of wealth in favour of the poor is brought about by reducing the wealth of the rich and increasing the income of the poor. The income of the richer sections can be reduced by adopting a number of measures, e.g., by progressive taxation on income, property etc., by imposing checks on monopoly, by nationalising social services, by levying duties on costly and foreign goods which are used by the rich and so on.

On the other hand, the income of the poor can also be raised in a number of ways, e.g., by fixing a minimum wage rate, by increasing the production of goods used by the poor, by fixing the prices of such goods, by granting financial assistance to the producers of these goods, by the distribution of goods through co-operative stores, and by providing free education, social security and low rent accommodation to the poor. When the distribution of income takes place in favour of the poor through these methods, the economic welfare increases.

But it is not essential that the equal distribution of national income would lead to increase in economic welfare. On the contrary, there is a greater possibility of economic welfare decreasing if the policy towards the rich is not rational. Heavy taxation and progressive taxes at high rates affect adversely the productive capacity, investment and capital formation, thereby decreasing the national income.

Similarly, when through the efforts of the government, the income of the poor increases but if they spend that income on bad goods like drinking, gambling etc. or if their population increases, the economic welfare will decrease.

Both these situations are not real and only express the fears, because the government, while imposing different kinds of progressive taxes on the rich, keeps particularly in view that taxation should not affect the production and investment adversely. On the other hand, when the income of a poor man increases, he tries to provide better education to his children and to improve his standard of living, his welfare increases.

  1. By Transfer of Wealth from the Poor to the Rich:

When as a result of increase in national income, the transfer of wealth takes place in the former manner, the economic welfare decreases. This happens when the government gives more privileges to the richer sections and imposes regressive taxes on the poor.