Question

What are a few implications of the first and second theorem of welfare economics? Ensure that you explain and link them to an example.

Please ensure that your explanations answer the question directly and that the answer is written in simple and easy to understand words so that an individual with no economics knowledge can understand. Do NOT copy and paste another answer from elsewhere and answer the question accurately. Do NOT provide me with a definition of the two theorems.

Answer 1

Welfare economics means maximum satisfaction of maximum number of people in a society. It has two fundamental theorem

1. First fundamental theorem

It explains that competitive equilibriums moves to Pareto efficient allocation of resources. That means they followed laissez-faire policy (let them free). This is the competitive market where there is no government intervention. Free forces of demand and supply will determine everything there. From this condition we move to Pareto efficient point that means impossible to make any one better off without making some one worse off. That means it works under perfect competitive market condition. Implications of first theorem are non govt movement leads to Pareto efficiency. This theorem creats market failure. which leads to information asymmetry etc.

Second fundamental theorem

It is just opposite of first theorem. That is the efficient allocation of resources is obtained by the competitive market with redistribution of resources. If any change in this process, we need to implement proper endowment rather than to intervene any change in the price system. for example a person is unable to have a decent housing, we need to adopt appreciate measure that is to increase his income and not introduce any price contol measures.

In the first theorem, if we fail to hold the market efficiency, it leads to market failure. In order to solve this government intervention is essential. As a result the first theorem would fail at that point.