Pareto Efficiency

Pareto equilibrium, or efficiency was named after Italian philosopher Vilfredo Pareto (1848-1924).

A Pareto equilibrium is a condition in which the allocation of resources is such that any change will be detrimental to someone.

Pareto efficiency is basic to the idea of trade and markets: I have a pound of bread, you have a pound of cheese. We are both want sandwiches so we're both become better off if we trade so we both end up with a half pound of each. That's a Pareto improvement.

But things get tricky if we don't place the same value on bread and cheese. If we agree that cheese is worth twice as much as bread then we can make a Pareto improvemnt. But it gets difficult if I think bread is worth more than cheese and you think that cheese is worth more than bread.

However, the example is a bit deceptive. Trading a half pound of bread for a half pound of cheese feels fair but, Pareto equilibrium does not necessarily have anything to do with fairness!

The diagrams at right show possible allocations of a pumpkin pie among three consumers. Assuming that each consumer likes pumpkin pie and prefers larger slices to smaller ones, which of the three are Pareto efficient?

household demand