Pareto Efficiency

Abstract

Few concepts are more widely used within economics than that of ‘efficiency’. It usually means not wasteful, or doing the ‘best’ one can with available resources. However, there are specialized usages; for example, the concept of efficient markets in the finance literature, or Leibenstein’s concept of X-inefficiency. Not all these meanings, even in academic work, have a common provenance. However, the concept as used in neoclassical economics has a precise but rather narrower meaning, given to it by Pareto, the Italian economist and sociologist, in his works Course in Political Economy and Manual of Political Economy around the turn of the twentieth century. He suggested the following definition: an allocation of resources in the economy was optimal if there existed no other productively feasible allocation which made all individuals in the economy at least as well-off, and at least one strictly better off, than they were initially. Although Pareto actually used the word ‘optimal’, this is really a definition of efficiency, as a Pareto-‘optimal’ allocation of resources is ‘good’ only in the limited sense that not everybody can be made better off. It may in fact be very undesirable in some other way, for example, very unequal. It is not surprising, therefore, that the word ‘Pareto-optimal’ has gradually been replaced by ‘Pareto-efficient’.

This chapter was originally published in The New Palgrave Dictionary of Economics, 2nd edition, 2008. Edited by Steven N. Durlauf and Lawrence E. Blume