The Social Science Encyclopedia, Second Edition
Pareto efficiency is a concept used by economists to define the efficient organization of an economy. Roughly speaking, it requires not only that production should be organized in an efficient manner, but also that this production should be distributed efficiently among consumers. In formal terms, an allocation of resources, which specifies not only what is produced with the basic resources available to the economy, but also how that production is distributed among consumers, is Pareto efficient if the following holds: there is no other feasible allocation in which no individual is worse-off and at least one individual is strictly better-off than in the initial allocation (equivalently, it is impossible to make someone better-off without simultaneously making at least one individual worse-off). Here, ‘feasible’ refers to what can be produced given the available resources and technology.
The Italian sociologist and economist, Vilfredo Pareto (1848–1923), was the first to use this definition of efficiency, although Edgeworth had earlier employed the same idea without apparently realizing its general applicability. Pareto efficiency is too weak to be equated with optimality in any meaningful sense, and consequently the term has gradually replaced the misleading ‘Pareto optimality’ in usage. The weakness of the concept stems from the fact that it has nothing to say about distributional issues. To put the matter at its starkest, imagine an economy with a fixed amount of a single type of good, say apples. Suppose that all the apples are allocated to a particular individual, who likes to have as many apples as possible, and everyone else gets nothing. This allocation is Pareto efficient as any other allocation will make our individual worse-off, but it is certainly not optimum in any reasonable sense. This weakness, however, is also the reason why it is the accepted definition of efficiency within orthodox theory. It is held to be value-free because its application requires no opinion as to the relative merits of different welfare distributions. Moreover, its use requires relatively weak information about individual welfare: it is only necessary to know how individuals rank alternative allocations; neither cardinal information about intensities of preferences nor interpersonal comparabilty of individual welfare is required.
The concept plays a central role in modern welfare economics. A key result is the so-called first theorem of welfare economics, which asserts that a competitive market economy will under mild conditions lead to a Pareto efficient allocation of resources.
This theorem is the formalization in a precise mathematical sense of Adam Smith’s ‘invisible hand’, whereby a society of individuals, each behaving in a self-seeking manner, results in an outcome which is to the common good in some sense. Pareto attempted unsuccessfully to establish this result; it was left to a later generation of theorists to come up with a satisfactory derivation.
Jonathan Thomas
University of Warwick
References
Pareto, V. (1897) Cours d’économie politique, vol. 2 Lausanne.
Edgeworth. F.Y. (1881) Mathematical Psychics, London.
Smith, A. (1776(1981]) An Inquiry into the Mature and Causes of the Wealth of Nations, ed. R.H.Campbell, A.S.Skinner and W.B.Todd, New York.
Further reading
Little, I.M.D. (1950) A Critique of Welfare Economics, Oxford.
Sen, A.K. (1979) ‘Personal utilities and public judgements: or what’s wrong with welfare economics?’, Economic Journal 89.
See also: economic efficiency; welfare economics.
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