Conditional Versus Unconditional Utility as Welfare Criterion: Two Examples

This paper provides two illustrative examples on how a choice of social welfare criterion (conditional vs. unconditional utility) can generate different welfare implications. The first example is based on the standard linear-quadratic permanent income model, and the other example uses a simple two-country DSGE model under autarky and under complete markets. When the conditional welfare criterion is used—with the social discount factor set at the private discount factor—we obtain the well-known results that the government should not intervene when there are no market imperfections and that complete markets generate risk sharing gains over autarky. In contrast, using an unconditional welfare criterion—which effectively implies that the social discount factor is set to unity—can generate unconventional welfare results.