Unit – 2

Pareto Optimality
Ms. Jumie George
Assistant Professor
Dept. of Economics
Stella Maris College (Autonomous)
 Assumptions
• There are only 2 individuals in the economy
• No inter-comparison of utility among A and B and hence there is no
subjectivity
• No envy or jealousy among A and B
 Re-allocation of resources or goods……
Results

BETTER OFF WORSE OFF

CASE 1 - A B
CASE 2 - B A

CASE 3 - A B
CASE 4 - B A
 Pareto’s Concepts
• Pareto efficiency, or Pareto optimality, is an economic state where
resources cannot be reallocated to make one individual better off
without making at least one individual worse off. 

• Changes to the allocation of resources in an economy can be made

such that at least one individual gains and no individuals lose from the
change is called Pareto Improvement. Such an economy is moving
towards Pareto efficiency.
Conditions for markets to be Pareto Optimal
• Exchange efficiency - for any given bundle of goods, it is not possible
to redistribute them such that the utility (welfare) of one consumer is
raised without reducing the utility (welfare) of another consumer.
• Production efficiency - when the available factors of production are
allocated between products in such a way that it is not possible to
reallocate the production factors so as to raise the output of one
product without reducing the output of another product.
• Output efficiency - where the combination of products actually
produced is such that there is no alternative combination of products
that would raise the welfare of one consumer without reducing the
welfare of another.
 Points to note
• Pareto Optimality is the result of rational economic behaviour on the
part of producers, consumers and owners of factors of production in a
perfectly competitive economy.
• Does not mean that there is only one 'optimal' allocation of
resources.
• A Pareto efficient economy results in the maximisation of aggregate
economic welfare for a given distribution of income and a specific set
of consumer preferences.
• Less practical to use as a policy tool 
• A standard against which economists can explore the real world