Talk:Pareto efficiency

From Wikipedia, the free encyclopedia

MISTAKE: In the criticism, the fact that one person can have no slice and someone else has 2 slice being pareto optimal assumes a linear utility function (i.e. that marginal utility doesn't decrease with wealth). Otherwise, the equitable allocation would be the best as everyone would have the highest possible utility for their slice. Hence this would be pareto optimal and not the inequitable solution. --203.158.33.213 06:26, 19 August 2006 (UTC)

I agree that a discussion of the different utility functions is badly needed in the article. Rather than to talk about a pie an example with fruit could be used: a boy got an apple and a girl received a banana from their respective fathers. However, both the two children preferred the other child's fruit compared with its own. Therefore, by changing fruits there would be a Pareto efficient solution. To a large, extent different utility functions are a reason why trade occur. Also, it might be a good idea to mention the common assumption that the extra utility from each extra piece of good decreases with each piece. In other words the first apple tastes better than the second and the second tastes better than the third etc. This influences the utility functions of all people for all sorts of goods and services. With different utility functions and different amounts of goods and services with different individuals it's clear that the total utility will increase if the goods and services are redistributed. This is the basic idea behind Pareto efficiency. In history there have been different ideas for how to accomplish this effect. The idea of (utopian) communism was that people would voluntarily hand over goods and services to people with great needs. Even without considering that people are too egoistic for this to work out, in a in world with many different kinds of goods and services and many individuals an information problem occur. How to collect and distribute information about the individuals’ utility functions, the number of different goods available, etc? In a market economy this is no problem since the relative utility functions of the population and the relative scarcity of goods in reflected in the price level for all goods and services. At the very beginning of the 20th century (before the Russian revolution) there was a debate between economists whether an adequate allocation of resources could be achieved in communism, since information about the relative scarcity was not given. Perhaps I should not get into depth on the different arguments in this extremely interesting discussion. Anyway critics of communism foresaw basically problems, which later occurred in economy of the Soviet Union. Strangely enough it's generally considered that the debate was won by the proponents of communism. The reason is that they came up with the concept that there should be artificial trading giving sort of market prices in an economy without personal ownership. In the Soviet Union the main sort of allocation was through administrative action. Therefore after a while changes in individuals' and companies' utility functions as well as relative scarcity of goods and services were no longer reflected in the prices of goods and services. This is one of the main reasons why it was so difficult for the Soviet Union to achieve Pareto efficient solutions. In short, Pareto efficient solutions can be reached in different ways, but in a system with flexible prices such solutions are easiest to attain through trade. Somehow these ideas should be added to the article in one way or the other.Smallchanges 18:34, 9 October 2006 (UTC)

I don't understand why it is considered better for someone to benefit at another's expense, rather than benefiting at no one's expense. Is it based on the assumption that if it is possible(to benefit at no one's expense), then resources were not being used properly? If this is true, it still seems that it would be desirable, as long as everyone was content, since no one would need to be made less content for others to become more content.

That basically is the idea behind Pareto efficiency. If something is not pareto efficient, then resources are not being used properly, since someone can be made better off without making any one else worse off. Is the page somehow confusing that? Jrincayc 14:49, 23 Nov 2003 (UTC)

"A change that can make at least one individual better off, without making any other individual worse off is called a pareto improvement."

"If an economic system is not Pareto efficient, then it is the case that some individual can be made better off without anyone being made worse off.

Aren't these contradictory? If the change makes someone better off without making anyone else worse off, it is an improvement. However, if the system is not pareto efficient, then you can make someone better off without anyone else being made worse off. So it's an improvement to make the system less pareto-efficient?

It is confusing at first read because the first sentence refers to an economic activity (change) whereas the second refers to an economic system. Simply put, they just say that an economic system will not be perfectly Pareto effecient if there are opportunities to engage in economic activities that contribute to Pareto efficiency. The second statement could be reformulated tautologically to say "If an economic system is not Pareto efficient, then a Pareto improvement would be possible. mydogategodshat 20:19, 7 May 2004 (UTC)

Contents 1 Local nature of optimization 2 'Corollary' 3 Removed material 4 about pareto efficiency in public finance 5 Pareto efficient is socialist 6 Dictator analogy, pie example 7 Incorrect affirmation 8 probably daft question: 9 Metric Spaces

[edit] Local nature of optimization

Suggested addition, along the lines of:

A key drawback of Pareto optimality is its localization. As the dictator example illustrates, there can be very many Local optimum points. The Pareto improvement criterion does not even define any Global optimum. Under a reasonable criterion, many Pareto-optimal solutions may be far inferior to the global solution. However, it might be argued that under all reasonable criteria the global optimum will also be Pareto-optimal. Indeed Pareto optimality might be one test of reasonableness.

I think I understand what you're trying to say, but I don't think that quite works. While it is important to stress in the article that there are almost always many Pareto optimal solutions, and that depending on the weighting factors (I think that's what you mean by criterion) some will be optimal while others will be suboptimal, you can't say that the number of Pareto optimal points is necessarily a disadvantage. In fact, for people who use Pareto fronts, that's normally considered an advantage. It lets you apply human judgement after seeing a range of solutions, instead of having to choose your weighting factors up front. moink 18:34, 28 Jul 2004 (UTC)

With that in mind, I would emphasize that Pareto efficiency is not really optimality in the ordinary sense, and only provides optimality, albeit robust optimality, in the most limited and local sense. Alex Stark 02:21, 2004 Aug 10 (UTC)

Good point. I'll add it. 137.222.40.132 17:14, 4 April 2006 (UTC)

[edit] 'Corollary'

I removed the text:

A corollary of a Pareto efficient economy that is desirable is that all workers make the same wage and all firms operate with the same profit margins.

I tend to think that this is value judgement. If the writer meant this in general, then they are saying that a coal miner (a dangerous, dirty job) should recieve the same wage as a librarian in a small town. Since the jobs are different, having the same wage would be unfair. Even Twin Oaks provides slightly different benefits to workers who do different jobs. Profit margins in industries are also likely to be different for reasons such as different risk and different capital startup costs. I have no objection to the idea in general that equality is good, but I would hesitate to call it a corollary, and inso much as it is mentioned in an article on Pareto efficientcy, it should probably be mentioned that it is trying for a different idea. Jrincayc 16:13, 3 Jan 2005 (UTC)

Reply by 69.107.96.61 5 Jan 2005. Hi Mr. Jrincayc. I am not a professional economist (like you?) but I believe that the corollary is not a value judgement but in fact a consequence of a pareto efficient economy (one that is at the boundary of the production possibility curve). This I recall from memory, years ago, from my Econ 101 class. I could be mistaken, but I think that once you reach the boundary, by definition all wage differentials, at the margin, will equal zero. That is, suppose that a wage differential exists for rocket scientists. A bunch of people will 'retool' and become rocket scientists, which will drive down the wage differential to zero. (In fact, in the aerospace industry, that's exactly what happened! Too many smart people in aeronautics, that's why I switched majors and became a lawyer). So, in a 'steady-state', long-term, quisscent 'Pareto optimal' economy, everybody makes the same amount of money (kinda like Communism and Sweden, but different). Anyhoo, I could be mistaken so I will let your revision stand. PS--I see we share some similar interests: IP and programming. Try C#.NET for a cool, easy to learn OOP language.--Cheers, User:69.107.96.61

Well, assuming that everyone was alike, there would still be differences in the amount that different jobs payed since the jobs themselves are different. A dangerous, dirty job that required lots of education would pay better than an safe easy job that required no education because if the jobs payed the same, then a person in the hard job would switch to the easy job. What would happen if everyone was the same is that the wages would hit a point so that people would be indifferent between the jobs, because the wage difference would exactly compensate for the differences in danger, effort and education... So the benefit of each job would be the same, but the monetary wage would be different. Since people are different, not even this happens completely, but there are effects to even out the overall benefits of different jobs. Jrincayc 13:58, 6 Jan 2005 (UTC)

Not to beat a dead horse, but I think confusion is with transient versus steady-state effects. "You" are thinking more transient, while "I" am thinking equilibrium (end-point) steady state. At the "steady state" time is infinity, so while people are different, and some jobs take more time to learn, and are more dangerous than others, and should and do initially yield more than safe, easy to learn jobs, at the limit (t = infinity) the wage differential goes to zero regardless of the job (so crab fisherman in Alaska, the world's most dangerous job next to conflict diamond mining in Angola, make the same as a desk receptionist in Peoria). Of course in the 'real world' this would never happen, but keep in mind Pareto optimal is a mathematical construct, not necessarily a real-world event (kinda like Adam Smith's 'perfect competition' where nobody has market power). Another corollary of Pareto optimal efficiency, as I recall, was that all investments and all corporations returned and earned an equal amount of money. The same principle applied: risky investment prices were 'bid up' by eager investors, until the return was the same as what the bank gives you. In fact, in a book called "Triumph of the Optimists: 101 Years of Global Investment Returns" by Elroy Dimson, Paul Marsh, Mike Staunton (good book if you can find a copy), it has been shown, on rather sketchy data, that in fact over the last 100 years, world wide, risky investments yielded about the same as riskless investments (I can relate to that--since the mid 90s my investments are running at about 3% a year compounded! Dang dot-com crash!). But let's agree to disagree on this one. For one thing, I support Wikipedia (have given money to them) but I think long-term it is best to keep the explanation of topics simple, for high-school kids and for quick rough outlines of topics rather than get into grad level discourse, which tends to confuse in an abbreviated format such as here. Cheers, 69.107.96.61 6 Jan 2005

I think that we may be in violent agreement. Let me try and define what I am talking about for the wages. First of all for a given job you have benefits you recieve such as money, health care, retirement and so forth. For a given job you also have costs such as your time, risk of death and dismemberment, physical effort, mental effort and so forth. You also have effort to get the job which includes things such as education, security clearences, licences and so forth. Lets call these benefit, cost, and obtain respectively. First, assuming that obtain is the same for two jobs, I would expect that under the long run people are the same assumetions (LRPS) for any two jobs a and b with the same obtain, benfit_a - cost_a = benfit_b - cost_b. I am pretty sure that this is the invariant, since if say benefit_a - cost_a > benefit_b - cost_b, then more people would want to work at job a than at job b. Since there are extra people trying for job a, and too few people trying for job b, supply and demand would tend to raise the benefits for job b and lower the benefits for job a. So, in the long run, I expect that benefit_a - cost_a = benefit_b - cost_b for all jobs a and b where obtain is the same. Note that this says that benefit_a = benefit_b only if cost_a = cost_b, and I am pretty sure that cost_a and cost_b will be different for many jobs (risk of death, physical effort and so forth vary for jobs). Now, how to deal with obtain. I hope we can agree that being a grocery clerk and being a professor of physics have different obtaining costs. One requires around a month or so of training, and the other requires around a 6-10 years of training (beyond high school). So, there is a different obtaining cost for each. Now, in the LRPS equilibrium, you will only choose a job with a higher obtain if you get greater net benefits later on. So, I think the equilibrium equation is: lifetime(benefits_a - costs_a) - obtain_a = lifetime(benefits_b - costs_b) - obtain_b. Lifetime is a rather complicated intergral that incorperates things like discounting and so forth (that I lack the interest to really calculate), but taking it as the sum of yearly benifits - cost for every working year is a reasonable aproximation. Now, if this is higher for job a than job b, then again, you would expect that there would be supply and demand mismatch issues, so benefits would be raised and lowered to fix that problem. So, as long as the obtain cost and the regular cost are different for different jobs, the benefits of each job will be different in the long run people same assumptions. However, each person will be indifferent to which job that they get (I think this is what you are remembering from your economics class).

As for businesses, I agree that in the long run, each business sector should be earning the same economics profits (but very different accounting profits). I hope this makes sense. If it doesn't tell me where so I can try and figure out if I made a mistake or I am being unclear. Jrincayc 16:20, 7 Jan 2005 (UTC)

[edit] Removed material

I have removed:

The Pareto conjecture hypothesizes that the real world does not contain any Pareto optimizations.

I have not heard of this conjecture. Please cite verifiable sources if you wish to return this sentence. It describes a dark world view indeed! mydogategodshat 00:48, 21 September 2005 (UTC)

Has anyone heard of BitTorrent? Check out http://bittorrent.com to learn about Bram Cohen's creation, which was created as a pareto efficient system.

[edit] about pareto efficiency in public finance

I have a homework about pareto efficiency in drug markets. question is "standart public finance theory suggest that patent rights on drugs must be protected because such rights guarantee pareto efficiency.is this true or false.discuss in details" if you can help to me I will be happy thanksssss

I think that is covered in WP:WINYH, which is to say Wikipedia is Not Your Homework. --Brokenfixer 06:46, 18 January 2006 (UTC)

[edit] Pareto efficient is socialist

This is a socialist hypothesis. It is utterly false in a free market, because there is no way to improve someone without consequences for someone else. Any regulation of the market breaks the definition of the free market that must have unknowable elements, such as new technology or competition for new ways and means--it is how the market become efficient in a free market by competition. The horse-carriage, by example, is no longer popular, but has been used since time immemorial and was replaced by the automobile (every new automobile took away from horse-carriage makers), and this means no economy could be Pareto efficient because the definitions of efficient are inadequate and incomplete. Automobiles dramatically increased the efficiency of Western World societies, and any regulation to prevent changes to make a fake efficient system would be quickly overrun by the other nations willing to throw out Pareto efficient and make the technology advances. Pareto efficient does not explain the modern technology markets and new efficiencies they develop.

This isn't a hypothesis, it's a mathematical concept. It has nothing to do with political philosophies, so please keep politics out of this article.

In any case, you're contradicting yourself. If there is no way to "improve someone without consequences for someone else" then that's Pareto efficient by definition.

Pareto efficiency is defined on a ceteris paribus basis, so whether new technologies emerge in future is irrelevant. 137.222.40.132 17:09, 4 April 2006 (UTC)

The condition for pareto inefficiency is not that improvements must have no consequences for somebody else in the absolute sense. There must simply be a net gain from an efficiency change after any "losers" are compensated. Please see below and also in the article for more on this.

Also, new productivity increasing technologies move the [production possibilities frontier] outwards, ie, increase what can be produced. This means that when a new technology becomes available not adopting it creates a pareto inefficiency, because the economy is not producing to its full potential.

[edit] Dictator analogy, pie example

I have removed the bit about a dictator being an undesirable Pareto efficiency. Pareto efficiency deals with markets, something definitionally unapplicable to dictatorships. This is also applicable to the silly bit above about it being somehow "socialist." Pareto efficiency is not about the winners winning more than the losers lose. Rather, it says that in a free market losers' loss will be negated by some other market compensation. 68.98.158.194

I reintroduced the example as it is very easy to understand, being somewhat extreme. If you don't like the dictator thing, maybe it would be better to reword the example than to remove it AdamSmithee 18:18, 13 May 2006 (UTC)

I removed the dictator example again but not because of any political preference. Unfortunately it was based on a common misunderstanding of the "better off with no worse off" necessary condition for Pareto efficiency. Acheivement of Pareto efficiency only creates the potential for this condition, but does not necessarily distribute wealth like this in practice. This is acheived in practice by compensation to those hurt by the policy change, with the efficiency gain outweighing the amount of compensation required and resulting a net gain. Thus, the case that a dictatorship is always a Pareto efficient economy is not correct, if a re-organisation can result in a net economic gain after the dictator has been compensated for his/her loss. Please see the other part of my edit in the begining section for changes explaining this.

I'm not entirely sure of the strict relevance of the pie example to the concept of Pareto efficincy either. It appears to prove that Pareto efficiency can exist alongside inequity due to social choice, but doesn't prove that Pareto efficiency drives inequity. We need a citation by Sen to prove that he was directing his critisism towards Pareto efficiency and that his ideas have not been extrapolated by others here.

I have serious doubts about the pie example as well or the need to invoke magic falling pies produced by no-one. MaxEnt 08:14, 18 July 2006 (UTC)

I don't consider the fact the pie falls out of the sky is a problem. Some real-life situations are very similar: Every year, Alaska gets a tax surplus which it must divide. That's a pie from the sky. They've been dividing it equally among residents, but obviously that's not the only way to divide. Technological advances that create new resources, such as new radio frequencies, are also similar. As an example, the "falling out of the sky" aspect of it is not a big problem to me.

My problem as to do with relating this pie example to Amartya Sen's work. I am (or rather, was) familiar with Sen's Paretian liberal paradox, but I have some difficulty relating that paradox to the pie ending up divided among 2 of the 3 players. Maybe some explanations would help. Haonhien 01:17, 20 September 2006 (UTC)

[edit] Incorrect affirmation

I removed this affirmation:

Also, the attainment of efficiency requires the presence of perfect competition, and is therefore a theoretical goal, not ever likely to be reached in reality.

as I think it is incorrect. In principle, a social planner could set up a system whitch is Pareto efficient. Please discuss before reintroducing AdamSmithee 18:18, 13 May 2006 (UTC) Bold text

I concur. Lack of perfect competition does not affect Pareto optimality. Transaction costs are another matter. Haonhien 01:19, 20 September 2006 (UTC)

[edit] probably daft question:

is there a typo somewhere in the following? : "If an economic system is Pareto efficient, then it is the case that no individual can be made better off without another being made worse off. It is commonly accepted that outcomes that are not Pareto efficient are to be avoided, and therefore Pareto efficiency is an important criterion for evaluating economic systems and political policies"

or is it a problem in my logic that an outcome in which everyone is made better off is "to be avoided"?

A situation in which everyone could be made better off should be avoided, yes -- rather than holding out on everyone, you should go ahead do whatever needs to be done to make them better off.

Would you want your boss to say that he could give you a raise but isn't going to (in order to prolong the situation of being able to give you a raise), or would you want him to give you the raise and then tell you that you can't have another one? Sanguinity 20:15, 13 November 2006 (UTC)

[edit] Metric Spaces

How do metric spaces play out in the definition of the Pareto set? What is the measure on R^n, and where does it come into effect in defining P(Y)? Sanguinity 20:23, 13 November 2006 (UTC)