Welfare and Decentralization

In this section, we test whether the agent can determine cases where the competitive equilibrium they calculate would yield the same distribution of resources and consumer welfare as that of a benevolent social planner directly making the consumption and production decisions of all agents directly (also known as the “Welfare Theorems”). In cases where the supply-and-demand relationships lead to the same results as those of a planner, the competitive equilibrium and its prices are said to “decentralize” the problem of a social planner. We then test that the agent recognizes cases where the welfare theorems fail, and can calculate the degree of welfare loss due to the distortions.

Elements

1. First Welfare Theorem

   Applying the first welfare theorem: competitive equilibrium allocations are Pareto efficient.

2. Second Welfare Theorem

   Applying the second welfare theorem: a Pareto-efficient allocation can be supported as an equilibrium after lump-sum transfers.