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 a 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.