Welfare economics deals with
normative issues. It does not
describe how the economy
works but assesses how well it
works.
Horizontal equity is the
identical treatment of identical
people. Vertical equity is the
different treatment of different
people in order to reduce the
consequences of these innate
differences.
A resource allocation is a
complete description of who
does what and who gets what.
For a given set of consumer
tastes, resources and
technology, an allocation is
Pareto-efficient if there is no
other feasible allocation that
makes some people better off
and nobody worse off.
A distortion exists if society’s
marginal cost of producing
good does not equal society’s
marginal benefit from
consuming that good.
The first-best allocation has
no distortions and is fully
efficient.
The first-best removes all
distortions. The second best is
the most efficient outcome that
can be achieved conditional on
being unable to remove some
distortions.
An externality arises if one
person’s production or
consumption physically affects
the production or consumption
of others.
Property rights are the power
of residual control, including the
right to be compensated for
externalities.
A free-rider, unable to be
excluded from consuming a
good, has no incentive to buy it.
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