Question

Illustrate and explain how the two fundamental theorems of welfare economics describe the relationship between competitive markets and Pareto efficiency

Looking for a proper solution with all relative diagrams included. I know what the theorems are and am looking for an emphasis on the "how" they describe the relationships

Approx 400 words

Answer 1

Here 2 fundamental theorems are try to explain.
Following are the fundamental theorems;

1. First fundamental theorem also known as the “Invisible Hand Theorem”
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

2.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

Competitive market and Pareto efficiency

A. Competitive market
A competitive market is when there are many producers competing to provide consumers with the goods and services needed. In acompetitive market, no single producer or consumer can dictate the market. Allcompetitive markets share five characteristics: profit, diminishability, rivalry, excludability, and rejectability.

​​​​B. Pareto efficiency

Pareto efficiency or Pareto optimality is a situation that cannot be modified so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off. ... A situation is called Pareto dominated if it has a Paretoimprovement.