Question

Describe the First and Second Welfare Theorem in economics.

Answer 1

There are two fundamental theorems of welfare Economics:

• First theorem :-States that under idealized conditions.
• Competitive equilibrium leads to.
• Allocation of Resources.
• This theorem is also known as" Invisible hand" theorem.
• Which means competitive equilibrium leads to allocation of Resources.
• Market leads to social optimum.
• Government assumes that theorem is needed to work in real life.
• It must be observed that a condition where all goods and the remaining population holds nothing is a pareto efficient distribution.
• Market maintains 3 attributes:-

1. Complete markets:-

• No transportation cost.

Perfect information.

2. Local nosatiation of preferences:-

• Original bundle of goods
• Close to other goods is preferred.

3. Price taking behavior:-

• No monopolist.
• Easy entry and exit.
• Case for non intervention in certain conditions.
• Allow the markets to do work and the out come will be pareto efficient.
• Short coming of theorem is that
• Transfer have to be large sum and
• Government should have perfect information on Individual consumers tastes and.
• Product possibilities of firms.

Second theorem:- States that allocation can be demonstrated by competitive Equilibrium.

It is a good definition of welfare.

Efficient allocation can be obtained by competitive equilibrium

Where market mechanisms leads to Redistribution.

This theorem is important because

Allows for a disconnection of efficiency and distribution matters.

Supporting government intervention.

Asking for wealth redistribution policies.

This theorem states that one can attain any particular thing by a lump sum wealth distribution

And allow the market to take over.

This theorem proofs in Two steps

• Pareto efficient allocation can be supported as a price- quasi Equilibrium with transfers.
• Give conditions under price-quasi equilibrium is also a price equilibrium.