Summary
Welfare economics analyses different states in which markets or the economy can be. Its main objective is to find an indicator or measure in order to guarantee that markets are behaving optimally, thus also guaranteeing that consumer welfare is as high as possible. In this Learning Path, we learn about the basics of welfare economics.Definition and main economists:
Efficiency and optimal allocation:
- Pareto efficiency
- Edgeworth box
- Production possibility frontier
- General equilibrium
- Fundamental theorems
There are two fundamental theorems of welfare economics.
-First fundamental theorem of welfare economics (also known as the “Invisible Hand Theorem”):
any competitive equilibrium leads to a Pareto efficient allocation of resources.
The main idea here is that markets lead to social optimum. Thus, no intervention of the government is required, and it should adopt only “laissez faire” policies. However, those who support government intervention say that the assumptions needed in order for this theorem to work, are rarely seen in real life.
It must be noted that a situation where someone holds every good and the rest of the population holds none, is a Pareto efficient distribution. However, this situation can hardly be considered as perfect under any welfare definition. The second theorem allows a more reliable definition of welfare
-Second fundamental theorem of welfare economics:
any efficient allocation can be attained by a competitive equilibrium, given the market mechanisms leading to redistribution.
This theorem is important because it allows for a separation of efficiency and distribution matters. Those supporting government intervention will ask for wealth redistribution policies.
