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What is Pareto Efficiency?

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Pareto efficiency is something you may sometimes hear mentioned in relation to economic theory. It is named after an Italian economist named Vilfredo Pareto.  The idea of a Pareto efficiency is not related to equity because something can be meet the requirements of Pareto efficiency but be very inequitable indeed. The idea of Pareto efficiency is of interest to economists and it is particular importance for game theory.

What is Pareto efficiency?

In order to explain what Pareto efficiency is, it might first be best to explain a Pareto improvement. A Pareto improvement occurs when there is a change in the allocation of resources which makes one person better off but doesn’t make anybody else worse off. For example if three people have 10 apples and one person gets one more apple it will be a Pareto improvement so long as the extra apple did not come at the expense of one of the other three individual’s apples. Pareto efficiency is said to exist when no other improvements can be made in the allocation of resources to one individual without it casing a loss to others.  A simple way of explaining Pareto efficiency would be to say that it refers to a situation where it is not possible to make one person better off without it necessitating other people being worse off.

The reason why Pareto efficiency is not the same as equity

The reason why Pareto efficiency is not related to equity is quite easy to understand. If one individual had a million apples and everybody else only had one apple then it would still be Pareto efficient so long as there is no way for the individual to get a million and one apples without it making everyone else poorer. If he could get a million and one apples without it making other people less well off then it could be described as Pareto efficient.

How is Pareto efficiency used?

The idea of Pareto efficiency is often used in the real world. It provides justification for increasing the resources given to one group if doing so does not lower the resources of other groups. All though Pareto efficiency is not concerned with equity there are many who would see it as fair.  When applying the concept to the real world there is often the idea of compensation; if a change causes a loss to one group they receive compensation so that there is no real loss.

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