The standard formulation of second best theory is:

if there is introduced into a general equilibrium system a constraint which prevents the attainment of one of the Paretian conditions, the other Paretian conditions, although still attainable, are,in general, no longer desirable.

Which Bohm summarises as a rejection of piecemeal policy: "here and there fulfilling the ‘Paretian conditions’– which, if applied everywhere, would lead to a Pareto optimum – regardless of whether these conditions actually were attained elsewhere"

The main implication of this is that policy analysis cannot be implemented without looking at very fine level data and complicated market interactions.
Is this fundamentally the take-away message in fields like trade and taxation policies where second best optimum is better understood?

  • $\begingroup$ My exposure to the notion of "second-best" throughout principal-agent and moral hazard models with asymmetric information is that it is the principal's optimum, given this asymmetry (e.g. an employer with workers of unknown skill, an insurer insuring possibly risky drivers, or a monopolist selling to consumers with unknown valuation). It is then contrasted with the first-best in order to see the principal's loss (and possibly the agent's gain) from the elimination of full information. $\endgroup$ – user11305 Sep 4 '18 at 18:33

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