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A First Welfare Theorem with Fully Socially Responsible Agents and its Limitations (with Botond Koszegi of University of Bonn)

In a competitive economy with externality-generating goods, we show an extension of the First Welfare Theorem: if consumers *and* producers are fully socially responsible, the competitive equilibrium achieves the first best. The key insight is that in competitive markets the impact of buying a good and the impact of producing it sum to one — so while one side may correctly invoke replacement logic (if I don't, someone else will), this necessarily means the other side cannot. The result relies on three assumptions, each stronger than what the classical FWT requires: (i) homogeneous and full social concern across agents; (ii) agents know the true impact of their actions; (iii) agents believe markets clear in response to their deviations. The result highlights that even with fully caring consumers, markets left to themselves cannot aggregate social concern unless producers also act responsibly — contrary to the Friedman doctrine.