Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society.

The principles of welfare economics are often used to inform public economics, which focuses on the ways in which government intervention can improve social welfare. Additionally, welfare economics serves as the theoretical foundation for several instruments of public economics, such as cost–benefit analysis. The intersection of welfare economics and behavioral economics has given rise to the subfield of behavioral welfare economics.

Two fundamental theorems are associated with welfare economics. The first states that competitive markets, under certain assumptions, lead to Pareto efficient outcomes. This idea is sometimes referred to as Adam Smith's invisible hand. The second theorem states that with further restrictions, any Pareto efficient outcome can be achieved through a competitive market equilibrium, provided that a social planner uses a social welfare function to choose the most equitable efficient outcome and then uses lump sum transfers followed by competitive trade to achieve it. Arrow's impossibility theorem which is closely related to social choice theory, is sometimes considered a third fundamental theorem of welfare economics.

Welfare economics typically involves the derivation or assumption of a social welfare function, which can then be used to rank economically feasible allocations of resources based on the social welfare they generate.

Until 1951, the objective of welfare economics remained largely uncontested. Economists viewed welfare economics as the branch of the discipline concerned with delineating the actions a governing body should undertake. It was commonly accepted that the term "maximizing welfare" held a specific meaning rooted in the philosophical framework of utilitarianism. Within the profession, there was ongoing debate regarding whether utility was an ordinal or cardinal concept. This debate seemed to have been addressed by Abram Bergson's seminal paper in 1938, "A Reformulation of Certain Aspects of Welfare Economics." Bergson demonstrated that economic efficiency conditions could be precisely formulated without fully specifying the underlying social welfare function. By postulating W as W(UA, UB) and assuming W to be a positive function of each individual's utility, it was shown that maximum welfare occurred when allocative efficiency was achieved, and the marginal contribution to welfare of each individual was equalized. But this decision did not last long. In 1951, Kenneth Arrow tested whether rational collective selection rules could derive social welfare functions from individuals in preference to social states. He argued that rational law satisfies four conditions: partial universality, the Pareto principle, totalitarianism, and free will. Arrow concluded that there is no rational way to articulate individual preferences forms together resulting in a harmonious social status of the various social societies.

Amartya Sen later emphasized the nature of the sequential gain approach, and Arrow's theory emphasized it. Sen said collective action often arises in social decision-making, because Arrow's theory is delivered through the aggregate of individual preferences rather than the formation of government or income, especially those that exist because of neutrality, presented a challenge to reconcile conflicting interests in revenue sharing. The neutral results, avoiding special utility issues, restricted the social analyzes to structural utility issues. This restriction did not exclude important information about an individual’s social status or position needed to make an income allocation decision. Sen recommended expanding the scope of data used in welfare research and emphasized the need for explicit discussion of ethics and morality in welfare economics.

The early Neoclassical approach was developed by Edgeworth, Sidgwick, Marshall, and Pigou. It assumes the following:

With these assumptions, it is possible to construct a social welfare function simply by summing all the individual utility functions. Note that such a measure would still be concerned with the distribution of income (distributive efficiency) but not the distribution of final utilities. In normative terms, such authors were writing in the Benthamite tradition.