Edited by Mark Blaug and Peter Lloyd
Chapter 36: Pareto Efficiency
Peter Lloyd Pareto efficiency is a concept that is central to general equilibrium theory and has wide applications in welfare economics and games theory. It is a general equilibrium concept applied to an economy with multiple agents making individual choices. Its attraction is that it avoids comparisons of the utilities or welfare levels between individual consumers. The concept is named after its inventor, the Italian economist Vilfredo Pareto. 1. THE CONCEPT OF PARETO EFFICIENCY Consider an allocation in some economy. This may be an allocation of a fixed bundle of consumer goods among a fixed number of consumers, or an allocation of a fixed supply of factors of production among a fixed number of goods. In general equilibrium, there are many possible allocations in each case and we seek an allocation or allocations which are best in some unambiguous and useful sense. Take, for example, the consumption allocation. Given the set of alternative allocations of the goods among the consumers, we say that there is a Pareto improvement if a movement from one allocation to another within this set makes at least one individual better off and does not make any other worse off. An allocation is said to be Pareto-efficient if there is no allocation which is a Pareto improvement. This definition has the very considerable advantages that it utilises only an ordinal concept of individual (or household) utility and it avoids interpersonal comparisons of levels of utilities. In general, there is more than one Pareto-efficient allocation and typically...
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