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To find the way to obtain the maximization of social welfare has been a focus of welfare economics. Pareto optimal conditions are usually considered a sufficient condition for the Welfare maximization, i.e., the first best solution. Under the mixed economy, however, it is almost impossible to reach this “Utopia” (pareto optimum) with institutional constraints such as monopoly and taxes. The second best solution then becomes the realistic and interesting problem few economists have paid attention to in the last two decades. In studying the second best theory, the following question arises: If a constraint, which prevents the satisfaction of at least one of the paretian conditons, is introduced into a general equilibrium system, which second best conditions depart from the corresponding paretian condition?

Demonstrates the implications of imperfect substitutability between domestic and imported final goods for the determination of second‐best nominal and effective tariffs in a general equilibrium setting. The analysis of second‐best interventions for given policy distortions extends that by Ruffin and Casas on homogeneous goods to the case where there is product heterogeneity. The second‐best optimal effective rate of protection for given policy distortions is shown to depend upon the nature of the policy distortion and the degree of substitutability between imported and domestic varieties. Although imperfect substitution reduces the extent to which effective protection can be determined from the structure of protection, it increases the extent to which second best tariffs can be determined in a qualitative sense at least when compared with the traditional, perfect substitution case.

Purpose − Instances of refusal to trade stand in contrast to the theorems on the gains from trade. Two paradigms, second-best and political economy, have been used to explain refusal to trade. Murray Kemp (1962) provided a foundation for the political economy paradigm when he noted that, in the absence of lump-sum redistribution, the theorems on the gains from trade are “true but irrelevant”. This chapter takes Murray Kemp's observation as a point of departure for a consideration of the relation between individual and group gains from trade. Paradigms in explaining refusal to trade are distinguished.

Methodology/Approach − This chapter examines ideas underlying explanations for refusal to participate in international trade.

Findings − Two different approaches are identified in modeling and explaining why the gains from trade are compromised by refusal of governments to allow free trade. The second-best approach suggests a justification for refusal to trade while the political economy approach with public-choice foundations proposes an explanation.

Practical implications − Ideology expressed in how governments are viewed can influence economic analysis.

The purpose of this paper is to study the incentive mechanism design problem of manager under the assumption of bounded rationality in the theoretical framework of principal‐agent relationship and provide some insights into the relationship between the economic agent's rationality and incentive mechanism.

The framework of principal‐agent relationship is based on the full rationality of the agents. However, the agents cannot make optimal decisions in the uncertain and imprecise environment. To capture the essence of incentive scheme, bounded rationality is introduced in the model and the gradient dynamics is applied in modelling bounded rational learning behavior. The corresponding single‐task principal‐agent problem is solved to obtain the second‐best contracts and the effort levels. Furthermore, the results are generalized for the multi‐task principal‐agent problem.

The second‐best contract under the assumption of bounded rationality converges to the optimal contract under the assumption of full rationality over time.

Accessibility of data for empirical research is the main limitation which model will be applied.

A useful reference for managerial decisions.

The new approach of bounded rationality modeling and simulation. This paper is aimed at the owners, enterprisers, managers, and workers.