Welfare economics

The concept of welfare is concerned with the well-being of the individual, and the subject matter of welfare economics is the influence of collective decisions upon the welfare of groups of individuals. The theorems of welfare economics constitute the rationale for the criteria of economic efficiency, the theoretical benefits of market competition, and the practice of cost-benefit analysis.

Fundamental theorems of welfare economics

In a market mechanism with flexible prices, individuals will continue to trade with each other until they reach an optimal outcome. The market provides a mechanism for individuals to communicate their preferences through prices so that each individual will be able to an optimal bundle of consumption given a particular budget constraint.

First theorem of Welfare Economics

In a market with many traders where prices are flexible, any equilibrium will be pareto-optimal.

Second theorem of Welfare Economics

Every outcome that is pareto-optimal can be realized in a market with many traders and flexible prices provided an appropriate initial distribution of endowments.