Pareto efficiency

Any point on a PPF, such as points ‘A’ and ‘B’, is said to be efficient and indicates that an economy’s scarce resources are being fully employed. This is also called Pareto efficiency, after Italian economist Vilfredo Pareto. Any point inside the PPF, such as point ‘X’ is said to be inefficient because output could be greater from the economy’s existing resources.

Any point outside the PPF, such as point ‘Z’, is impossible with the economy’s current scarce resources, but it may be an objective for the future. Pareto efficiency can be looked at in another way – when the only way to make someone better off is to make someone else worse off. In other words, Pareto efficiency means an economy is operating at its full potential, and no more output can be produced from its existing resources.

Pareto efficiency is unlikely to be achieved in the real world because of various rigidities and imperfections.  For example, it is unlikely that all resources can be fully employed at any given point in time because some workers may be in the process of training, or in the process of searching for a new job. While searching for work, or being trained, they are unproductive. Similarly, an entrepreneur may have wound-up one business venture, and be in the process of setting-up a new one, but during this period, they are unproductive. Despite this, Pareto efficiency is still an extremely useful concept.

It is a useful concept for two reasons:                           

1.      It can be an objective for an economy because it can set a direction towards which an economy can move.

2.      It can help highlight the imperfections and rigidities that exist in an economy and prevent Pareto efficiency being achieved.

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