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Unit-24: Pigovian Welfare Economics and Externalities

Notes
Fig. 24.4

b
T e
B E
Goods-Y b

d e l 1
D l
d
O X X X C
1 2
Goods-X

Like Pigou, Baumol suggests that external efforts can be rectified through the methods of tax and
subsidies and ideal output can be achieved. If the output of commodity X is more than the ideal output
like on point D then by imposing heavy taxes on each unit of output, the output can be reduced. On
the contrary, if the production of commodity X is less than ideal output as on point B, then by giving
subsidy for each unit of output, we can increase the output. We can achieve ideal output only when the
amount collected as tax can equal the subsidy paid by the government.

24.5 Summary

• To maximize the welfare, the distribution of national income is significant. If national income is
fixed then transfer of income from rich to poor will further the welfare. According to Pigou, such
transfers have less impact on rich compared to poor as a result of which the economic condition
of poor improves. The condition of welfare is based on Pigou’s dual concept “equal capacity for
satisfaction” and “Diminishing marginal utility of income”.

24.6 Keywords

• Dual Criterion: Two types of principles
• External Effects: Outer Effect

• Over Production: More Production
• Unitization: Process of being one

24.7 Review Questions

1. What are Pigou’s welfare concepts? Explain.
2. Comment on external economies of production.
3. What are the measures of social restriction proposed by Pigou to obtain ideal output or highest welfare?
4. What do you understand by Pigou’s concept of ideal output?

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