Question

Define Pareto Optimality. State the three conditions for Pareto optimum. What are the four main criticisms to Pareto's welfare theory?

Answer 1

A state of affairs is Pareto-optimal (or Pareto-efficient) if and only if there is no alternative state that would make some people better off without making anyone worse off. More precisely, a state of affairs x is said to be Pareto-inefficient (or suboptimal) if and only if there is some state of affairs y such that no one strictly prefers x to y and at least one person strictly prefers y to x. The concept of Pareto-optimality thus assumes that anyone would prefer an option that is cheaper, more efficient, or more reliable or that otherwise comparatively improves one’s condition.

Pareto Optimality Conditions:

For the attainment of Pareto-efficient situation in an economy, three marginal conditions must be satisfied.

These are:

(i) Marginal condition for efficiency in the allocation of factors among firms (efficiency in production);

(ii) Marginal condition for efficiency of distribution of commodities among consumers (efficiency in consumption); and

(iii) Marginal condition for efficiency in the allocation of factors among commodities (efficiency in product-mix or com­position of output).

Criticisms

1 )The economists of the Austrian School question the relevance of Pareto optimal allocation considering situations where the framework of means and ends is not perfectly known, since neoclassical theory always assumes that the ends-means framework is perfectly defined.

2) Some even question the value of ordinal utility functions. They have proposed other means of measuring well-being as an alternative to price indices, willingness to pay functions, and other price-oriented measures. These price-based measures are seen as promoting consumerism and productivism by many. It is possible to do welfare economics without the use of prices; however, this is not always done.

3) Value assumptions explicit in the social welfare function used and implicit in the efficiency criterion chosen tend to make welfare economics a normative and perhaps subjective field. This can make it controversial.

4) However, perhaps most significant of all are concerns about the limits of a utilitarian approach to welfare economics. According to this line of argument, utility is not the only thing that matters and so a comprehensive approach to welfare economics should include other factors. The capabilities approach is an attempt to construct a more comprehensive approach to welfare economics, one in which an individual's well-being and agency are evaluated in terms of their capabilities and functionings.