In economics, the functioning of the market is often discussed through modeling the behavior of economic entities that participate in it. Such is the approach of welfare theory; it assumes consumers that maximize their preferences and businesses that maximize profits. The theory of welfare economics provides a framework for thinking about the desirability of the resulting equilibria. In this work we define its basic concepts and focus on three basic theorems of welfare economics. The first two theorems of welfare economics speak to the relationship between price equilibria and Pareto optimality. In addition to Pareto optimality, an important criterion useful in judging the state of the economy is given by the social welfare function. These concepts are complemented by the formulation of the third theorem, Arrow’s impossibility theorem, which presents some necessary limitations in aggregating preferences of individuals.
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