Question

10.Explain the First Fundamental Theorem of Welfare Economics.​

Answer 1

First fundamental theorem of welfare economics (also known as the “Invisible Hand Theorem”): any competitive equilibrium leads to a Pareto efficient allocation of resources.

Answer 2

Answer:

There are two fundamental theorems of welfare economics. The first theorem states that a market will tend toward a competitive equilibrium that is weakly Pareto optimal when the market maintains the following two attributes:

1. Complete markets with no transaction costs, and therefore each actor also having perfect information.

2. Price-taking behavior with no monopolists and easy entry and exit from a market.

Furthermore, the first theorem states that the equilibrium will be fully Pareto optimal with the additional condition of:

3. Local nonsatiation of preferences such that for any original bundle of goods, there is another bundle of goods arbitrarily close to the original bundle, but which is preferred.

The second theorem states that out of all possible Pareto optimal outcomes one can achieve any particular one by enacting a lump-sum wealth redistribution and then letting the market take over.