The Pareto Criterion

What does an allocation entail?

-A description of who does what, the consequences of their actions, and who gets what as a result.

What does the Pareto Efficient entail?

-An allocation with the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off.

What does Pareto Dominance infer?

-When such an allocation, A, dominates another allocation, B, if at least one party would be better off at A than B, and nobody would be worse off

Why is Vilfredo Pareto (1848-1923) a great economist

-He came to propose Pareto’s Law after observing that the distribution of wealth resembled a similar bell curve. Very few rich people. lots of poor people

-His 80-20 rule thus meant that the richest 20% of the population usually holds 80% of the wealth. In America, its actually 90%

-Famously, he stated that there were two fundamental ways of getting wealthy. By creating value and by capturing value.

What is the Pareto Criterion?

-A change is Pareto-improving if at least one person benefits, and no one becomes worse off

-A situation is Pareto-Efficient if no further Pareto improvements are possible

Why is the concept of Pareto-Efficiency something that needs some care into how is it utilised?

-Usually more than one PE allocation

-Pareto Criterion says nothing about which PE allocation is better

-If an allocation is PE, it doesn’t mean we should approve it - ignores fairness, by a lot

-Even if such an allocation is Pareto-inefficient, it doesn’t mean it is worse

In the Ultimatum game of splitting £100, why can this expose the limitations of Pareto efficiency?

-Because every single allocation will be seen as PE.

-Even the Proposer getting £99.99 and the Responder getting 1p is PE because any change will harm at least one party.

-Note that an offer of £0 is actually Pareto-inefficient, because both parties get nothing.