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The Third Theorem of Welfare Economics: Report from a Fictional Field Study

Karine Nyborg ()

No 12269, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: The perfectly competitive market – a hypothetical situation free of market failure – is the basis for the two fundamental welfare theorems, and an important benchmark for economic theory. The radical abstractions of this idea, however, make its full implications hard to grasp. I address this using literary fiction. Part I discusses fiction as a tool for economic theory. Part II is a story about a journey to the perfectly competitive market. Part III develops main theoretical insights based on the story: First, complete social isolation is needed to preclude market failure. Second, the requirements of symmetric information and no external effects are extremely hard to reconcile, leading to an impossibility theorem: if trade is permitted anytime, and deliberate, welfare-relevant learning is feasible, no perfectly competitive market can exist.

Keywords: perfect competition; narratives; social interaction; symmetric information; complete contracts; labor markets (search for similar items in EconPapers)
JEL-codes: A11 D60 D62 D82 (search for similar items in EconPapers)
Date: 2019-03
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