Introduction

Regulation seeks the same outcome that an ideally functioning market can achieve. However, it usually is undertaken where markets cannot or do not function in the ideal way. The great framework of welfare economics, in which – under ideal conditions – competitive markets reach a Pareto optimal allocation of resources, can be deployed to define an ideal against which regulation can be compared. Welfare economics is not an infallible guide to such policies, for it can require strong assumptions. Not all the important features of a particular market may be captured as a result. Some framework for representing economic welfare is needed before optimal pricing can be defined and described, though, and the logical soundness of welfare economics makes it a good starting point for clear thinking about regulatory problems.

We begin by noting how rigorous analysis of individual welfare can be developed and related to observable demand behavior for a single good or service. The problems of assessing welfare effects in cases involving more than one good or service are treated, and individual preferences or welfare are aggregated to obtain measures of welfare for a group or an entire economy. In aggregating representations of individual well-being we must face the issue of income distribution. We discuss the assumptions typically made about income distribution in welfare measures and illustrate them by application to the choice of socially optimal prices.