Question

. Define Pareto improvement. Using Vilfredo Pareto’s criteria, how can we confirm that a Pareto improvement has taken place? Give one brief example.

B. Define Pareto efficiency Using Vilfredo Pareto’s criteria, how can we confirm that we have Pareto efficiency? Give one brief example. C, D. In Ontario, Canada sales tax is 14%. Personal income taxes also are higher than in the US. Their higher sales tax and income tax funds government guaranteed medical care. Separately answering as parts C and D, give and explain two different reasons why their medical funding methods are contrary to the objectives of Vilfredo Pareto. (note: This question asks for Pareto’s reasoning, not your own.)

Answer 1

SOLUTION:

PART 1

The solution to this can be explained with the help of an Edgeworth box diagram that indicates situations of Pareto Improvement, Pareto Efficiency etc.

Now, assume there exists a hypothetical situation where there are 2 players in the market, the People and the Government. Their consumption patterns are indicated through the Edgeworth Box, where X₁, X₂, and so on are the Indifference curves for say People X, and they indicate different levels of utility or satisfaction for the people.

Red ICs for People.

Also, the ICs Y₁, Y₂, etc. show the Utility levels of Government Y and their consumption starts from the top right corner of the Edgeworth Box.

Blue ICs for Government.

To explain the concepts of Pareto Improvement, and Pareto Efficiency or Pareto Optimal, say that the economy is at Point A on the Edgeworth Box diagram. PARETO IMPROVEMENT is any such movement which leaves at least one person better off, without making anyone worse off. Thus, we see that Movement from A to B creates a situation of Pareto Improvement where the Government moves to a higher utility IC (say due to higher tax receipts), i.e. Y₂ to Y₃, whereas People remain on the same IC X₃ indicating no utility loss. Thus, this movement is known as Pareto Improvement.

Again, movement from A to C is just the same as before, where the People are better of after movement to higher IC X₄ from X₃, whereas Government is same as before with no utility loss. Thus, movement A to C can also be termed as a Pareto Improvement.

Now, such combinations where any further Pareto Improvement is NOT possible are termed as Pareto Efficient or PARETO OPTIMAL conditions. Thus, Points B and C are points, after which Pareto Improvement are not possible. Say any movement ahead to Point D, will lead the Government into Disutility, whereas People will benefit after moving to higher IC.

Thus, if we join all such Pareto optimal points, we receive a CONTRACT CURVE as indicated by the green curve. The contract curve indicates all such points which are Pareto Efficient in an Edgeworth Box Diagram.

P.S. The Edgeworth Box is just the combination of 2, 2-dimensional graphs for 2 different groups of people. Inverting one person's curve and placing it in the other gives us an Edgeworth Box.

PART 2

The second part of the question can be answered with the help of a critical analysis of Pareto's Theory.

High Taxes, usually create benefits for the government as they can spend more freely on providing public facilities for the people in the society. Say, for example, higher Income and Sales Taxes leads to better infrastructure development and better social public facilities for the people. However, there are several shortcomings in the process.

For such processes to be Pareto Optimal, there must be EQUITABLE DISTRIBUTION which is one of the most prominent critiques of the Pareto Model. The collection of Taxes and distribution for Medical Facilities is a classic example of INCOME DISTRIBUTION in the society which is not always justified in the social sense. For example, say 100 people pay Taxes, whereas only 40-50 are benefiting from the health infrastructure in the country. In this situation, the Government might move to a high IC, however, the People may become worse-off leading to contradictory results. The Pareto Improvement and Pareto Optimal conditions attract great criticism when issues related to the political economy and income distribution are concerned. Uneven distribution may lead to falling utility for a number of people. Again, the society comprises of two-income groups, wealthy people and poor people. If wealthy people are made better off, while poor people (who comprise a major chunk of the population) are made worse off, the Pareto Efficient condition may not hold in that case. Thus, higher Taxes does not ensure Equitable distribution and return to the people in the society, and may not be Pareto Optimal.

Thus, in this case the Higher Taxes in Canada may not always be Pareto Improving or Pareto Optimal if they are Uneven and DO NOT ensure distribution equitably. In this case, the medical funding method may not be appropriate and contrary to the objective of Welfare Maximization and Pareto Optimality as indicated by Vilfred Pareto.