Islamic economics and a third fundamental theorem of welfare economics

Hayat Khan

The World Economy, 2018, vol. 41, issue 3, 723-737

Abstract: The discipline of economics started as a moral science but became detached from moral concerns over time to emulate natural science and to adopt positivism. Consequently, mainstream economics assumes people to be sordidly selfish. The teachings of Islam, however, promote social preferences where individuals should be other†regarding and have preferences over social outcomes. This paper replaces the selfish agent with a social agent and presents the results in a theorem referred to as the third fundamental theorem of welfare economics (TFTWE). The TFTWE states that “when the selfish agents are replaced with the social agents, market outcomes are Pareto optimal, equitable, and unique†. This is an important result which has widespread implications. We show that the TFTWE holds under conditions where the first two fundamental theorems of welfare economics fail and that a Walrasian equilibrium is more likely to exist when selfish preferences are non†convex. Unlike the popular convention, there is no equity†efficiency trade†off. In fact we point to the possibility of reversal in equity†efficiency trade†off.

Date: 2018
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