Social Welfare

I’m puzzled about something, maybe you can help me out.

Economists sometimes talk about a concept that I am going to refer to as the level of social welfare. Basically this is how much utility, or satisfaction, the society is enjoying as a whole. Here’s a simple example: imagine a society that consists of just two people, Bob and Frank. Bob has a banana that he would like to sell to Frank. Bob is willing to sell the banana for any amount greater than $1. Frank is willing to buy the banana for any amount less than $2. Bob is a good negotiator, so they eventually agree on a price of $1.75.

In this example, the sale of the banana increases the wealth of both parties. Bob traded something he valued at $1 for $1.75, so he gained $.75 worth of value.  Frank gave $1.75 for something that he valued at $2.00, so he gained $.25 worth of value. The level of social welfare in Frank and Bob’s society has increased by $1.00, because of the sale of the banana.

So the level of social welfare, as measured by economists, has to do with how much value people place on different items, and on how those items are distributed through the society. Moving goods and services from people who value them less to people who value them more will increase the total level of social welfare in the society. This is basic microeconomics.

The thing that bothers me is this: How much a person is said to value any particular good or service is measured in dollars. That is a relative measure, because it’s really comparing how much the person values the good or service against how much she values dollars.

And how much she values dollars depends on how many dollars she has.

Is this an objective way to measure the level of social welfare in a society? If I am very poor then this measure of social welfare under represents my preferences, needs, desires. Here’s a simple example: two starving men approach a baker who has one loaf of bread left to sell. The baker, having studied microeconomics, knows that the man who values the bread the most will be willing to pay the highest price. One of the starving men has $2 in his pocket, the other has $5. The baker sells the loaf for $5, confident that the man who offered only $2 wasn’t as hungry as the man who offered $5.

Obviously, the prices that the two men are willing to pay do not adequately reflect the value they would receive from the bread.  This is a serious problem. It undermines the legitimacy of calculations of social welfare. It also undermines the legitimacy of the price mechanism as a welfare maximizing means of distributing goods and services.

Is there a legitimate, objective way to separate preferences or utility from ability to pay? Is there some way to put the preferences of the poor on equal footing with the preferences of the wealthy, at least for academic purposes?