Market failures

Abstract

The so-called fundamental theorem of welfare economics is demonstrated in the preceding chapter. Apart from the problem of income distribution, the competitive market mechanism can generate an optimal social state in the sense that the resultant allocation of resources is Pareto optimal. Several conditions are, of course, assumed explicitly and implicitly to prove the theorem. If one regards these conditions approximately realistic, the best conceivable policy is that of laissez-faire, as far as the allocation of resources is concerned. Indeed, the fundamental theorem of welfare economics is the modern foundation of the historically celebrated doctrine of free trade.