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Unit-24: Pigovian Welfare Economics and Externalities

is complete contest, the scenario of superior or ideal output is created. But, contrary to other experiments, Notes
in any one experiment if the value of marginal social output of institutions is less, then the unique product
can obtain by changing more profitable factors through social restriction and taxes and subsidies.
Professor Baumol has given new description to Pigou’s concept of ideal output and related it to Pareto’s
complete control. According to his definition, ideal output is that on which there can be no re-division
of various experiments of economic institutions which can take society, compared to previous state it
was in, to a better place. The definition of this ideal output is similar to that Pareto condition according
to which welfare is maximum when through any economic regrouping the condition of one person,
without changing the situation in the other, can be made better than it was earlier.
Baumol has described the problems of ideal output in the dictionary of modern analytical tools of
economic welfare. His analysis is based on following assumptions—(1) there is competition in the
demand for readymade goods in market. (2) There is proper distribution of all goods in the society.
(3) Taste and technology never change in society. (4) Every person in a society gives preference to the
maximum volume of the product and not the least volume. (5) The limit of placement of institutions is
given. (6) There are no external effects of consumption and output. (7) The indifference curves do not
intersect each other. (8) In economics, only two goods, X and Y, are produced.

Please state your thoughts on Pigou’s concept of ideal output.

When these assumptions are provided, Baumol has proved in graphical form how a society reaches
a situation of ideal output. Just concentrate on Fig. 24.3. In this figure, the production of object X is
measured on horizontal axis whereas the production of object Y is measured on vertical axis. I, I and
1
I are indifference curves which show the various coincidences of objects available to society. On any
2
point the indifference curve shows the gradient of the objects between X and Y the rate of substitution
(MRSxy). TC is a pictorial curve that, using available institutions and technology, shows various
production co-incidences. A gradient of transfigurational curve on any point proportionally measures
the social marginal cost (SMC) of X from the social marginal cost of Y. The gradient of transfiguration
curve, in our example, is marginal rate of substitution between X and Y. This value line of MRT ,
xy
MSC /MSC is PL whose gradient makes P /P appear.
x y x y
On point E, the society achieves a state of ideal output where transfiguration curve TC touches the highest
possible group curve I . On this highest level, the society produces and consumes object OX of X and OY
1
1
1
of Y. If there is any other speed other than point E on curve TC then would appear compared to group at
much less indifference curve, like the I curve, and compared to welfare may appear at lower limit.
It can be proved that this ideal output is actually a competitive output. Because the belief is that there is
total competitiveness and there is lack of external effects; therefore in the entire market the price of both
commodities remains same. Thus from the demand side, control is exercised on point E where the value
line PL touches the marginal curve I . Thus on point E.
1
MRS = P /P ...(i)
xy x y
From the supply side, it is essential, for competitive control, that the gradient of value line is certainly
equal to the gradient of transfiguration curve, that is

P /P = MRT ...(ii)
x y xy
In the complete market, MRT marginal personal cost of MC of Y is equal to the rate of marginal personal
xy
y
cost of MC of X. Because it is assumed that there is no effect in production and therefore marginal personal
x
cost of production is equal to marginal social cost of production. Thus, the transfiguration curve says
MRT = MC /MC = MSC /MSC
xy x y x y

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