Pareto efficiency

Pareto efficiency, or Pareto optimality is a central concept in game theory with broad applications in economics, engineering and the social sciences. An allocation of resources is Pareto efficient if there is no way that some individual could be made better off without making any other individual worse off. A change that can make at least one individual better off, without making any other individual worse off is called a pareto improvement.

The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.

If an economic system is not Pareto efficient, then it is the case that some individual can be made better off without anyone being made worse off. It is commonly accepted that such inefficient outcomes are to be avoided, and therefore Pareto efficiency is an important criterion for evaluating economic systems and political policies.

In particular, it can be shown that, under certain idealised conditions, a system of free markets will lead to a Pareto efficient outcome. This was first demonstrated mathematically by economists Kenneth Arrow and Gerald Debreu, although the restrictive assumptions necessary for the proof mean that the result may not necessarily reflect the workings of real economies.

Not every Pareto efficient outcome will be regarded as desirable. For example, consider a dictatorship run solely for the benefit of one person. This will, in general be Pareto optimal, because it will be impossible to raise the well being of anyone except the dictator without reducing the well being of the dictator, and vice versa. Nevertheless, most people (except perhaps the dictator) would not see this as a desirable economic system.

There is often more than one Pareto efficient outcome for a given amount of resources. For example with a dictatorship, both with dictator Alice or with dictator Bob, the outcome will be Pareto efficient because in the first instance it will be impossible to raise the wellbeing of anyone without reducting Alice's benefit and similarly for Bob.