In
welfare economics, 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 and
Kelvin Lancaster 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 desi ...
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 t ...
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 ...
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 cases.
References
External links
Introduction to Second Best in legal theory
{{DEFAULTSORT:Second best
Microeconomic theories
Market failure
Welfare economics