Term of the Week: Pareto Efficiency


Pareto efficiency, or Pareto optimality, is an economic state where resources cannot be reallocated to make one individual better off without making at least one individual worse off.
Named after Vilfredo Pareto, an Italian economist it is founded on the basis that if an economy’s resources are being used inefficiently, it ought to be possible to make somebody better off without anybody else becoming worse off. Pareto efficiency implies that resources are allocated in the most efficient manner, but does not imply equality or fairness.

Vilfredo Pareto


Hypothetically, if there were perfect competition and resources were used to their maximum efficient capacity, then everyone would be at their highest standard of living, or Pareto efficiency.In practice, it is almost impossible to take any social action, such as a change in economic policy, without making at least one person worse off —which is why the concept of Pareto improvement has found a wider use in economics. A Pareto improvement occurs when a change in allocation harms no one and helps at least one person, given an initial allocation of goods for a set of persons. The theory suggests that Pareto improvements will keep enhancing value to an economy until it achieves a Pareto equilibrium, where no more Pareto improvements can be made.

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