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Thursday, January 3, 2013

The Welfare Theorem and Ethical Economic Rationality

The Moneylender and his Wife - Quentin Matsys (1514)
Economics and the process of earning revenue from the system can be a moral imperative that fosters both the growth of the capitalistic system as well as the free market principles theorized by founding masters such as Adam Smith. According to Welfare Theorem only a system that self-regulates and adjusts naturally to market forces can ensure higher levels of needs fulfillment for the vast majority of society. In such a situation society climbs the economic ranks by constant adjustments and readjustments to supply and demand.

In the book Economics as a Moral Science Bernard Hodgson states, "since the inauguration of systematic studies in economics by the moral philosopher Adam Smith, philosophers and social scientists have engage in an unflagging controversy regarding the proper method of inquiry to adopt in the construction of economic science" (Hodgson, 2001, pp. 1). Economic science, and any other science, is subject to varying methods of inquiry. However, in most studies the removal of values from the theoretical consideration of elements have been common. To Bernard Hodgson economic science and morality are intertwined by their natural outcomes.

The theorists von Neumann and Morgenstern's postulated in his work entitled Theory of Games and Economic Behavior that economics includes a utility function that is maximized by the patterns of behaviors, probabilities, and maximization of choice (1944). In essence, each consumer of the system seeks to maximize their choices and opportunities within the system. This eventually can lead to normative and rational behavior that can encourage homeostasis. In the case of needs attainment it can provide economic values based in part on the economic options available to people as they make their choices.

If the market were unmolested higher levels of societal values will develop based upon self-interest. According to the Pareto-optimality Theorem, or commonly called Welfare Theorem, unmolested markets will not only achieve a level of homeostasis but will also create a higher level of moral fabric (Holdsworth, 2011). Growth of a nation becomes a moral imperative that rests on the free market system whereby companies contribute to the national economy by adjusting to economic forces in a rational way. In order for a constant adjustment of the market to exist, whereby all members rise together, it requires limited market interference by government.

Hodgson further moves on to state what equilibrium is in his perspective (2001, pp. 178),"...a ‘‘competitive’’ market we shall refer to the fact that each decision-maker, i.e. consumer or firm, takes prices as given and not subject to its decision. Broadly put, then, a general competitive equilibrium would be one wherein there existed a set of prices for all commodities such that for each commodity the total goods demanded by consumers equalled the sum of the quantity originally available and the total produced by all firms.’’Such equilibrium is said to exist when production and demand are in balance.  Over production (i.e. flooding from China) can create havoc on an economic system by dumping the value of a good and causes a pendulum shift to over fulfillment of demand (i.e. undervalued products and low profit margins).

Thus a morally sound society, without over influence or market manipulation, is considered an extension of Adam Smith concepts of natural liberty. It is the liberty to produce and earn reward through the system for needs obtainment without tyranny. "...as the conviction that the morally right thing to do is that which brings about a state of society that is the realization of something deemed to be morally valuable" (Holdsworth, 2011). Moral principles help to ensure a self-correcting society where human dignity affords the opportunity to keep the fruits of one's labor. When the system goes out of balance there is a characteristic unfair manipulation of market forces.

It may be difficult to understand how economic activity and morality work hand-in-hand. To Bernard Hodgson the economic system can produce morality through rational choices that further leads to  homeostasis in demand and supply and therefore leading to the rise of the financial welfare of its people. Without a free market the natural economic forces will lead to manipulation of supply and demand and thus create an inability of citizens to make rational choices. In American society it is this ability to make free choices that is tied to the concept of liberty.

Hodgson, B. (2001). Economics as moral science. New York: Springer.

Holdsworth, G. (2011). Economics and the limits of optimization: steps towards extending Bernard Hodgson's Moral Science. Journal of Business Ethics, 108 (1).


von Neumann, J., & Morgenstern, O. (1944). Theory of games and economic behavior. Princeton: Princeton University Press.




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