Lecture 1b
Fundamental Theorems of Welfare Economics
Environmental Economics, Politecnico di Milano, Academic Year
2015-2016
Giovanni Marin
IRCrES-CNR, Milano
e-mail: [email protected]
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Outline of the lecture
ˆ First theorem of welfare economics
ˆ Second theorem of welfare economics
ˆ Book paragraphs for this lecture: Varian, 31.4, 31.5, 31.6, 31.7, 31.8,
31.9, 31.10, 31.11
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Environmental Economics - Lecture 1b
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First theorem of welfare economics
ˆ We have already seen it (at least partly)
ˆ For a given initial endowment of X and Y to A and B, markets will
lead to an efficient allocation of consumption
ˆ Individuals will exchange goods on the market (with Pareto
improvements) and adjust relative prices up to the efficient equilibrium
ˆ Remember that efficiency does not entail equity!
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First theorem of welfare economics
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Second theorem of welfare economics
ˆ It is also true, however, that each efficient equilibrium is characterized
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by a unique budget constraint line
As the indifference curves of A and B are tangent in the equilibrium,
only one line can be tangent as well
The slope of the line reflects relative prices
The intercept reflects wealth endowments ⇒ w A and w B
As relative prices of a specific efficient equilibrium are determined by
the slope of indifference curves, the only degree of freedom to attain
that specific efficient allocation is the endowment of wealth given to
individuals
Second theorem of welfare economics ⇒ changing the endowment (of
wealth) across individuals allows to reach any of the Pareto efficient
allocations
Rationale: non-distortionary redistribution of income preserves
efficiency and can be used to attain a specific Pareto efficient
equilibrium
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Second theorem of welfare economics
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