THE VALIDITY OF PIECEMEAL 2ND-BEST POLICY

If there are irreducible distortions in one sector of an economy, when is it optimal to set consumer prices proportional to producer prices in the other sector? For the case of a single consumer, Jewitt demonstrated that implicit separability of the consumer's preferences is necessary and sufficient for the optimality of piecemeal second-best policy. We show that in a multi-consumer economy piecemeal policy is optimal if and only if the aggregate compensated demand system has a two-sector representation. Only three broad classes of economies can have two-sector representations. This considerably restricts the circumstances in which piecemeal second-best policies are optimal. © 1991.