Question

Discuss relationship between National Income and Economic Welfare by studying changes in national income and changes in its distribution.

Answer 1

Relationship between national income and economic welfare:

Pigou established that national income and economic welfare are closely related because both are measured in monetary terms. Generally, when national income increases, economic welfare tends to increase, and vice versa. However, this relationship is not straightforward and depends on several factors. The effect of national income on economic welfare can be studied in two ways:

1. Changes in the size of national income:

• Positive change: When national income increases, people can consume more goods and services, potentially leading to an increase in economic welfare.
• Negative change: A reduction in national income generally leads to lower economic welfare.

However, this simplistic view of the relationship depends on the following important considerations:

• Manner of increase: Economic welfare does not necessarily increase if the rise in national income comes from exploitation, such as workers toiling longer hours for lower wages. Such a rise is not welfare-enhancing.
• Per capita income: National income alone is not a reliable indicator if population growth matches or exceeds income growth, as per capita income may not increase, and welfare might remain stagnant.
• Composition of output: If the increase in national income comes from more production of capital goods but a shortage of consumption goods, economic welfare may not increase. For example, during wartime, national income may rise, but the public’s standard of living may fall due to scarcity of consumer goods.

2. Changes in the Distribution of National Income:

• Transfer of wealth from poor to rich: If the increase in national income leads to a transfer of wealth favoring the richer sections of society, economic welfare for the majority (especially the poor) declines.
• Transfer of wealth from rich to poor: On the other hand, redistribution of income from the rich to the poor, for example through progressive taxation, minimum wage laws, or social welfare programs, can enhance overall economic welfare. This helps reduce inequality and improves the living standards of the poor.