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A critique of Ng's third-best theory

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Abstract

The theory of second best established that the effect on community welfare of any one policy change varies with the specific context in which that change occurs. In paper that has been frequently quoted to justify specific policies, Ng argues that fulfilling firstbest conditions piecemeal is an optimal policy under quite general conditions when neither full first nor second best optima are achievable. This paper first argues that Ng's conclusion does not follow from his own assumptions, which imply instead that the status quo should be maintained, whatever it might be. Next it gives one illustrative example showing how much damage can be caused by following Ng's advice. It then argues that when Ng's key assumption is replaced by one that is closer to the facts, there is no general a priori presumption for adopting any specific policy, including maintaining the status quo. The paper closes with some observations on the usefulness of welfare economics even when the full implications of second best theory are accepted.

Suggested Citation

  • Richard G. Lipsey, 2012. "A critique of Ng's third-best theory," Discussion Papers dp12-02, Department of Economics, Simon Fraser University.
  • Handle: RePEc:sfu:sfudps:dp12-02
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    File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp12-02.pdf
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    References listed on IDEAS

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    1. Yew-Kwang Ng, 1987. "Equity, Efficiency and Financial Viability: Public-Utility Pricing with Special Reference to Water Supply," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 20(3), pages 21-35.
    2. Ng, Yew-Kwang, 1984. "Quasi-Pareto Social Improvements," American Economic Review, American Economic Association, vol. 74(5), pages 1033-1050, December.
    3. R. G. Lipsey & Kelvin Lancaster, 1956. "The General Theory of Second Best," Review of Economic Studies, Oxford University Press, vol. 24(1), pages 11-32.
    4. Richard Lipsey, 2007. "Reflections on the general theory of second best at its golden jubilee," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 14(4), pages 349-364, August.
    5. Ng, Yew-Kwang, 2000. "The Optimal Size of Public Spending and the Distortionary Cost of Taxation," National Tax Journal, National Tax Association;National Tax Journal, vol. 53(2), pages 253-272, June.
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    Cited by:

    1. Richard G. Lipsey, 2013. "Some contentious issues in theory and policy in memory of Mark Blaug," Chapters,in: Mark Blaug: Rebel with Many Causes, chapter 6, pages 31-62 Edward Elgar Publishing.

    More about this item

    Keywords

    Second best; third best; reaction function; piecemeal welfare policies;

    JEL classification:

    • D60 - Microeconomics - - Welfare Economics - - - General
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis

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