The First Fundamental Theorem Of Welfare Economics

Introduction When studying market structure, the First Fundamental Theorem of Welfare Economics states that markets will distribute resources efficiently if the following conditions are met: the market is perfectly competitive, there are no externalities or public goods, markets are complete, and there is no asymmetric information (Gruber, 2013). If a healthcare market complied with these four pillars of the First Welfare Theorem, a healthcare provider’s choice of output would not affect the price of the service, ultimately leading to Pareto efficiency. As seen in Figure 1, the consumer demand curve would be horizontal, as average revenue, marginal revenue, and price would be the same, constant value. Figure 1: Perfect Competition†¦show more content†¦If the provider produces one extra unit of a good or service, the overall price decreases. The provider receives a lower price for infra-marginal goods, or the goods that would have been sold without reducing the price (Png, 2012). For example, if a healthcare provider chooses to increase production from 100 units to 200 units, the price must be reduced from $50 to $40. The provider will gain revenue (100 x $40= $4,000) from the additional units, but will lose ($50-$40) x 100= $1,000) the 100 infra marginal units that the provider could have sold at the higher price. So, average revenue for the provider will be $40, while marginal revenue will be $30. Thus, average revenue and price remain equal, while marginal revenue now falls below the price curve (Png, 2012). Figure 2: Marginal Revenue Curve vs. Average Revenue Curve in a Monopoly In order to determine price, the monopolist utilizes the inverse demand curve, also known as the average revenue curve. This curve reflects the price the provider would need to charge to produce demand at a particular level. 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