Economics of Agents with Social Preferences:
 The Third Fundamental Theorem of Welfare Economics

Hayat Khan
Department Finance
La Trobe Business School
Faculty of Business Economics and Law
 La Trobe University, Bundoora 308.

h.khan@latrobe.edu.au

Abstract. Proof of the existence of equilibrium and the first and second fundamental theorems of welfare economics are believed to be the most remarkable achievements of modern microeconomic theory as they are at the heart of the debate between interventionist and non-interventionist and equity-efficiency trade-off. Interestingly, the debate motivated by moral concerns assumes that individuals are sordidly selfish. This paper revisits the debate thereby replacing the selfish agent with a social agent (an agent whose choices are sensitive to the social outcome of her selfish choices). The outcome of this objective exercise is summarized in the ‘third fundamental theorem of welfare economics which is shown to be pareto-improvement over the two fundamental theorems of welfare economics. The market, perfectly competitive or otherwise, endogenously achieves an equitable and efficient solution. It also makes a case for the equity-efficiency trade-off reversal and endogenous return to altruism.