Welfare, GDP Fetishism , Inequality, Consumption, & Happiness.

Introduction

The word "welfare" has two very different meanings in economics. The most familiar meaning to the general public is that it refers to a collection of government programs such as food stamps and Medicare, usually intended to help the poor.
However, economists more often use the word "welfare" in a very different sense--as a synonym for wellbeing. Welfare or wellbeing refer to an overall condition, emphasizing happiness and contentment, though also including one's standard of living in financial or material ways. Welfare in this sense more commonly refers to the condition of an entire country or economy, which is sometimes emphasized by using the phrase "social welfare." Welfare in the sense of wellbeing turns out to be an easier concept to imagine than to analyze carefully. It is even harder to measure.
Economists have always recognized that not all happiness derives from being financially well off. We all know that being wealthy is not the same as being happy. However, it is rather hard to quantify happiness, and even harder to aggregate happiness across people because people generally have a variety of tastes. Consequently, over the years economists have invented some specialized technical names for happiness, including utility, satisfaction, preferences, tastes, indifference curves, wellbeing, and welfare.
The concept of social welfare sometimes leads to discussions of the distribution of income and income inequality.

Definitions and Basics

GDP Fetishism 

When economics professors teach the basics of Gross Domestic Product (GDP), we usually caution our students that it is not a good measure of welfare. Unfortunately, many economists go on to give GDP far more credit than it deserves. They tend to consider fiscal and monetary policy positive if these policies increase GDP, but they often fail to ask, let alone answer, whether those same policies increase or reduce welfare. I have a term for giving GDP such a sacred a place in economists' reasoning: GDP fetishism. If we return to some basic principles of economics, we will avoid GDP fetishism, do better economic analysis, and propose better policies.

To see why GDP is not the same as wellbeing [I use "welfare" and "wellbeing" interchangeably], consider the definition of GDP. One of the most careful definitions is in The Economic Way of Thinking, 10th edition, by Paul Heyne, Peter Boettke, and David Prychitko. They write: "The gross domestic product is the market value of all the final goods produced in the entire country in the course of a year." Most economists would agree with this definition. It turns out, though, as Heyne et al. point out, that even this careful definition does not accurately characterize GDP, let alone wellbeing. It is inaccurate in two ways. First, because there is usually no market for the things that government produces (the U.S. Postal Service being one of the exceptions), government spending on goods and services is valued at cost rather than at market prices. Second, because many goods and services are not bought or sold, even though they would have a market value if they were, these goods and services are not counted in GDP. In early editions of his best-selling textbook, Economics, the late Paul Samuelsongave his favorite example of this pitfall in GDP accounting. Samuelson pointed out that if a man married his maid, then, all else equal, GDP would fall....

Welfare, 

The U.S. welfare system would be an unlikely model for anyone designing a welfare system from scratch. The dozens of programs that make up the "system" have different (sometimes competing) goals, inconsistent rules, and over-lapping groups of beneficiaries. Responsibility for administering the various programs is spread throughout the executive branch of the federal government and across many committees of the U.S. Congress. Responsibilities are also shared with state, county, and city governments, which actually deliver the services and contribute to funding.

The six programs most commonly associated with the "social safety net" include: (1) Temporary Assistance for Needy Families (TANF), (2) the Food Stamp Program (FSP), (3) Supplemental Security Income (SSI), (4) Medicaid, (5) housing assistance, and (6) the Earned Income Tax Credit (EITC). The federal government is the primary funder of all six, although TANF and Medicaid each require a 25-50 percent state funding match. The first five programs are administered locally (by the states, counties, or local federal agencies), whereas EITC operates as part of the regular federal tax system. Outside the six major programs are many smaller government-assistance programs (e.g., Special Supplemental Food Program for Women, Infants and Children [WIC]; general assistance [GA]; school-based food programs; and Low-Income Home Energy Assistance Program [LIHEAP]), which have extensive numbers of participants but pay quite modest benefits....

Inequality, Consumption, & Happiness. 

How well-off are we? Using economic data, economics professor Steve Horwitz addresses questions about inequality, consumption, happiness, and well-being. Are the rich getting richer and the poor getting poorer? Is there income mobility in the United States? Are Americans happy? Are we "objectively" better off than we used to be? ...

Richard Epstein on Happiness, Inequality, and Envy.

Richard Epstein of the University of Chicago talks with EconTalk host Russ Roberts about the relationship between happiness and wealth, the effects of inequality on happiness, and the economics of envy and altruism. He also applies the theory of evolution to explain some of the findings of the happiness literature....

Marginalism, 

Adam Smith struggled with what came to be called the paradox of "value in use" versus "value in exchange." Water is necessary to existence and of enormous value in use; diamonds are frivolous and clearly not essential. But the price of diamonds--their value in exchange--is far higher than that of water. What perplexed Smith is now rationally explained in the first chapters of every college freshman's introductory economics text. Smith had failed to distinguish between "total" utility and "marginal" utility. The elaboration of this insight transformed economics in the late nineteenth century, and the fruits of the marginalist revolution continue to set the basic framework for contemporary microeconomics.