Welfare economics

Government policy is a frequent topic in welfare economics.

Economics is both a positive science and a normative science. Economics as a positive science studies how markets and economies work, regardless of whether or not those institutions produce a desirable result. Welfare economics is the normative study of the types of outcomes that an economic system should be producing, and whether or not those outcomes are being produced.

The problem of interpersonal utility comparisons

Welfare economics addresses the issue of interpersonal utility comparisons by using observations about consumption as a vector of choices rather than a utilitarian summation of the utility they derive from a particular consumption bundle. When making comparisons between more than one individual, a particular allocation of resources is pareto-optimal if you could not make one individual better off without making another person worse off.

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.