Fundermental Theorem of Economic Welfare

Welfare economics is the systematic method of evaluating the economic implications of alternative resource allocations. Welfare analysis answers the following questions: i) Is a given resource allocation efficient? And ii) who gains and who loses under various allocations, and by how much? Welfare economics provides the basis for judging the achievements of markets and policy makers in allocating resources. Its most powerful conceptual tool is the utility possibility frontier. This defines the set of utility allocations that can be achieved in a society subject to the constraints of tastes and technologies. Modern welfare economics is formally summed up in two so-called fundamental Theorems. The First Fundamental Theorem states that, states that under certain assumptions a state resulting from a competitive equilibrium is Pareto optimal, while the Second Fundamental Theorem states that every Pareto-optimal allocation of resources is an equilibrium for a perfectly competitive economy, provided a redistribution of initial endowments and property rights is permitted or every Pareto-optimal allocation of resources can be realized as the outcome of competitive equilibrium after a lump sum transfer of claims on income.
First fundamental theorem of welfare economics (also known as the “Invisible Hand Theorem”) states that any competitive equilibrium leads to a Pareto efficient allocation of resources. The First fundamental theorem of economic welfare was established under the following assumptions; perfect competition, each individual chooses his consumption bundle to maximize his utility subject to his budget constraint, each firm chooses its production vector, or input–output vector, to maximize its profits subject to some production constraint, assume self-interest, or the absence of externalities (An individual cares only about his own utility, which depends only on