Pareto efficiency: An economic allocation is inefficient if there is an alternative allocation in which all agents are better off in terms of their own objective functions (utilities, profits, payoffs); it is said to be Pareto efficient if there is none such alternative allocation. Put differently, in an Pareto efficient state, it is impossible to improve one agent's state without making at least one other agent worse-off. This criterion generalizes the one of a maximal aggregate surplus to situations with incomparable objective functions (preferences). It is weak in that typically entire continua of Pareto efficient states exist; the criterion is therefore important mainly as a negative one, ruling out (institutions leading to) inefficient states as undesirable. With incomplete information about the agents' preferences, the notion of Pareto efficiency is ambiguous. An operational criterion of efficiency then depends on the state of the resolution of uncertainty: different allocations can be compared in terms of their ex-ante, their interim, or their ex-post efficiency.
Literature: Reiter (1987)
|Entry by: Jan Vleugels and Joachim Winter|
June 17, 1999
Direct questions and comments to: Glossary master