Pareto efficiency

Definition

An allocation is Pareto efficient if there is no other allocation in which some other individual is better off and no individual is worse off.

Notes:

Examples and exercises on Pareto efficiency

Pareto efficiency and competitive equilibrium in an exchange economy

We can show the following result.
If every trader cares only about the bundle she has (not the bundle any other trader has) then a competitive equilibrium allocation is Pareto efficient.
Notes This result is the main economic argument in favor of using markets to allocate goods. Thus if you wish to make an economic argument against the use of markets you need either to question the assumptions behind the result or to point to the weakness of the conclusion. The main assumption is that all goods are "private": each person's welfare depends only on her own consumption bundle, not on anyone else's. Two reasons why the conclusion is weak are:

Argument for the result. Why is the result true? For simplicity, think of a situation in which there is a single good, each seller has one unit of the good, and each buyer can buy either nothing or one unit of the good. Suppose that the buyers and sellers differ in how they value the good. Then the demand Qd(p) at the price p is the number of buyers whose value for the good is at least p. Similarly, the supply Qs(p) at the price p is the number of sellers whose value for the good is at most p.

In a competitive equilibrium in this market the buyers who trade are those who value the good most highly, and the sellers who trade are those who value the good the least. Is there any other pattern of trade that results in someone being better off without anyone being worse off?

Examples and exercises on Pareto efficiency and competitive equilibrium
Copyright © 1997 by Martin J. Osborne