welfare economics Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level. Attempting to apply the principles of welfare economics gives rise to the field of public ec ...

, the theory of the second best (also known as the general theory of second best or the second best theorem) concerns the situation when one or more optimality conditions cannot be satisfied. The economists

Richard Lipsey Richard George Lipsey, (born August 28, 1928) is a Canadian academic and economist. He is best known for his work on the economics of the second-best, a theory that demonstrated that piecemeal establishing of individual first best conditions w ...

and

Kelvin Lancaster Kelvin John Lancaster (10 December 1924 – 23 July 1999) was an Australian mathematical economist and John Bates Clark professor of economics at Columbia University. He is best known for the development of the Theory of the Second Best with R ...

showed in 1956, that if one optimality condition in an

economic model In economics, a model is a theoretical construct representing economic processes by a set of variables and a set of logical and/or quantitative relationships between them. The economic model is a simplified, often mathematical, framework desig ...

cannot be satisfied, it is possible that the next-best solution involves changing other variables away from the values that would otherwise be optimal. Politically, the theory implies that if it is infeasible to remove a particular market distortion, introducing one or more ''additional'' market distortions in an interdependent market may partially counteract the first, and lead to a more efficient outcome.

Implications

In an

economy An economy is an area of the production, distribution and trade, as well as consumption of goods and services. In general, it is defined as a social domain that emphasize the practices, discourses, and material expressions associated with the ...

with some uncorrectable

market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indiv ...

in one sector, actions to correct market failures in another related sector with the intent of increasing economic efficiency may actually decrease overall economic efficiency. In theory, at least, it may be better to let two market imperfections cancel each other out rather than making an effort to fix either one. Thus, it may be optimal for the government to intervene in a way that is contrary to usual policy. This suggests that economists need to study the details of the situation before jumping to the theory-based conclusion that an improvement in market perfection in one area implies a global improvement in efficiency.

Application

Even though the theory of the second best was developed for the Walrasian

general equilibrium In economics, general equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an ov ...

system, it also applies to

partial equilibrium In economics, partial equilibrium is a condition of economic equilibrium which analyzes only a single market, ''ceteris paribus'' (everything else remaining constant) except for the one change at a time being analyzed. In general equilibrium ana ...

cases.

References

External links

Introduction to Second Best in legal theory
{{DEFAULTSORT:Second best Microeconomic theories Market failure Welfare economics