Introduction

In a decentralised market economy, prices play two roles: an economic role, as prices guide production and consumption decisions; and a financial role, as prices determine the receipts of the seller and the expenditure (hence the real income) of the buyer. The first role is geared to efficiency of resource allocation; the second is related to equity of the personal distribution of real incomes…

The dual role of prices is obvious in the case of wages. In a market economy, the level and hierarchy of wages guide the labour demand by firms; and wages determine the real incomes of workers. An economically efficient use of human labour, free of involuntary unemployment as well as unfilled job offers, may lead to an ‘inequitable’ income distribution. (The meaning of ‘inequitable’ is explained below.) This may be linked to the functional distribution between capital and labour, or to the wage disparities by skills. In this paper, I use a streamlined model, with identical workers and a single wage rate; but I consider the spread between wages and unemployment benefits.

The second theorem of welfare economics suggests a general solution to the potential conflict between efficiency and equity. Under the conditions of the theorem, every Pareto-efficient allocation of resources corresponds to competitive clearing of all markets, under an appropriate redistribution of wealth (i.e. under a proper set of individualised lump-sum taxes and transfers).