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A critique of Ng's third-best theory

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.

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File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp12-02.pdf
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Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp12-02.

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Length: 16
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:sfu:sfudps:dp12-02
Contact details of provider: Postal: Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
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Web page: http://www.sfu.ca/economics.html
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Order Information: Postal: Working Paper Coordinator, Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
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  1. Richard Lipsey, 2007. "Reflections on the general theory of second best at its golden jubilee," International Tax and Public Finance, Springer, vol. 14(4), pages 349-364, August.
  2. 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.
  3. Ng, Yew-Kwang, 1984. "Quasi-Pareto Social Improvements," American Economic Review, American Economic Association, vol. 74(5), pages 1033-50, December.
  4. Ng, Yew-Kwang, 2000. "The Optimal Size of Public Spending and the Distortionary Cost of Taxation," National Tax Journal, National Tax Association, vol. 53(n. 2), pages 253-72, June.
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