Describe the First and Second Welfare Theorem in economics.

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Expert Solution

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:-

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.

Rahul Sunny answered 1 year ago

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