Welfare, Government Intervention and Political Economy

In all economic reasoning the fundamental questions are, on the one hand, how the allocation of resources is made — how the factors of production of the economy are employed in different activities — and, on the other hand, how the resulting output is distributed among the citizens and what the welfare consequences of a given allocation are. As far as the resource allocation is concerned, there are in principle two possibilities: either the allocation is handled impersonally by the ‘market forces’, or administrative processes are used. In the latter case resources are allocated with the aid of more or less central planning. In practice the economic system virtually always represents a mix of the two ways of organizing an economy. In a market economy the public sector usually plays a reallocating role, and in addition resources are usually allocated inside both firms and the public sector by administrative processes, not by markets. The branch of economics that deals with how well the allocation of resources functions is welfare economics. When you pass judgements with respect to the impact of different characteristics of markets or of policy interventions you are after the welfare effects.