# Difference between revisions of "Pareto efficiency criterion"

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− | A particular allocation of resources, or a particular arrangement, is said to be '''Pareto efficient''' or '''Pareto optimal''' (or equivalently, is said to have '''Pareto efficiency''' or '''Pareto optimality''') if there is no ''Pareto improvement'' possible. A Pareto improvement is an alternative allocation or arrangement in which ''no'' party is | + | A particular allocation of resources, or a particular arrangement, is said to be '''Pareto efficient''' or '''Pareto optimal''' (or equivalently, is said to have '''Pareto efficiency''' or '''Pareto optimality''') if there is no ''Pareto improvement'' possible. A Pareto improvement is an alternative allocation or arrangement in which ''no'' party is worse off and at least one party is better off. |

The criterion of Pareto efficiency is termed the '''Pareto efficiency criterion''' or '''Pareto criterion.''' | The criterion of Pareto efficiency is termed the '''Pareto efficiency criterion''' or '''Pareto criterion.''' |

## Latest revision as of 18:14, 28 February 2012

## Definition

A particular allocation of resources, or a particular arrangement, is said to be **Pareto efficient** or **Pareto optimal** (or equivalently, is said to have **Pareto efficiency** or **Pareto optimality**) if there is no *Pareto improvement* possible. A Pareto improvement is an alternative allocation or arrangement in which *no* party is worse off and at least one party is better off.

The criterion of Pareto efficiency is termed the **Pareto efficiency criterion** or **Pareto criterion.**

## Facts

- Generally, all points on a
*frontier*are Pareto efficient, while all points on the inside are not. For instance, given a production possibility curve, the Pareto efficient production possibilities are precisely the possibilities*on*the curve, while production possibilities in the interior region are not Pareto efficient because production of both goods can be increased. - Pareto efficiency is a fairly weak criterion and there can be multiple very different arrangements that are Pareto efficient, as described for instance by the multiple points on the production possibility curve.
- Because of this problem of Pareto efficiency being too weak to yield unique allocations, we often consider a modified version where gainers are in a position to compensate losers (known as the compensation principle). For instance, an outcome in which gets 100 units and B gets 3 units is not a Pareto improvement over an outcome in which and both get 5 units, but if we allow to provide partial compensation to , we can get an outcome that
*is*a Pareto improvement over an outcome where and both get 5 units. A modification of the Pareto criterion that accounts for*potential*compensation (Without necessarily including the compensation as part of the arrangement itself) is termed the Kaldor-Hicks efficiency criterion, also called the**potential Pareto criterion**.