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Price Distortion and Potential Welfare

Kunio Kawamata

Abstract

We study an economic model where one group of agents is guided by different prices from those of another group. This situation arises, e.g., in the case of excise taxes, subsidies, and import and export tariffs in international trade. It is established that a decrease in the specified divergence between the equilibrium price vectors implies an increase in welfare in a certain natural sense. The result broadens a conclusion of a classical theorem of welfare economics and answers a question of Foster and Sonnenschein [6]. It also has some bearing on the theory of second best.