Pareto Optimality and Welfare Economics

Vocabulary flashcards covering Pareto optimality, the Edgeworth Box, Marginal Rate of Substitution, Potential Pareto Criterion, and Welfare Analysis based on the lecture notes.

Efficiency

The extent to which output is maximized and/or effort is minimized through the use of a machine, method, strategy, or process.

Pareto Criterion

A technique for comparing or ranking alternative states of the economy, stating that state B is ranked higher than state A if moving to state B makes at least one person better off without making anyone else worse off.

Pareto Optimum

A state of the economy from which it is impossible to make one person better off without making another person worse off.

Utility Possibility Curve

A curve corresponding to all possible combinations of utility for two individuals for a given production possibility frontier.

Edgeworth Box

A diagram that depicts the distribution of commodities between two people in a pure exchange economy.

Marginal Rate of Substitution (MRS)

The maximum amount of a good that a consumer is willing to give up in order to obtain one additional unit of another good, equal to the magnitude of the slope of an indifference curve.

Convexity

The shape of an indifference curve that reflects a diminishing marginal rate of substitution along the curve.

Pareto Improvement

A reallocation of resources that makes one person better off without making anyone else worse off.

Contract Curve

The locus of all the set of Pareto efficient points in an Edgeworth Box, where the indifference curves of two individuals are tangent.

Potential Pareto Criterion

A modification of the Pareto criterion stating that State A is preferable to State B if it is potentially possible for the gainers to compensate the losers and still remain better off, without requiring actual compensation.

Kaldor-Hicks Compensation Test

Another name for the Potential Pareto criterion, which forms the basis for comparing or ranking alternative states of the economy by cost-benefit analysis using the compensation principle.

Welfare Analysis

An evaluation concept that gives different weights to the net benefits of different people, typically weighting net benefits inversely by the income or wealth of the recipients.