Welfare economics

Abstract

Welfare economics studies the measurement and promotion of societal welfare. The first fundamental theorem states that in a competitive market, equilibrium is Pareto efficient. However, it is criticized for its unrealistic assumptions. The second theorem finds that the market, modified by lump-sum transfers, can achieve any Pareto optimal distribution. Still, it ignores distribution. The third theorem asserts the nonexistence of Arrow social welfare functions that satisfy certain reasonable requirements. This makes aggregating individual preferences and solving distribution problems logically challenging. Social choice functions have been studied as alternatives but face strategy-proofness problems. Maskin’s theorem shows that preferences can be truthfully elicited in Nash equilibria of a certain mechanism that implements a desired social choice function. – AI-generated abstract.