Before defining the Pareto efficiency, it is useful to specify what is now called the Pareto principle. The Pareto principle requires that, given two social states (or allocations, in the present context) a and b, if a is Pareto greater than b in the sense that everyone is better in a than in b, then a is better condition than b.

Any social state a will be said to be Pareto efficient, if there is no other possible state b which is Pareto greater than a. We still need to clarify what we mean by the term better off, a question which is facilitated by the notion of utility function.

It is assumed that each person derives some utility from the batch of products assigned to him by each possible allocation, defined as a set of batches of products, one batch for each person in the economy. If the utility that it obtains from its batch of products under an allocation a is greater than the utility that it obtains from its batch of products under another allocation b, then we will say that it is better with the allocation a than with the allowance b. And if everyone is better, in this sense, under allocation a than under allocation b, then a is Pareto-greater than b.

Welfare economics is also very much concerned with the notion of social welfare function (SWF). Considering any possible allocation a, a SWF associates a number W with a, which is supposed to reflect the overall welfare produced by allocation a. Typically, W would depend on the utility that each person derives from the product bundle assigned to them in the allocation in question. This utility is assumed to be ordinal, that is to say, imbued only with the property of classification. In addition, individual public services are not assumed to be interpersonal comparable. Finally, SWF W is assumed to be Pareto inclusive, which simply means that all things being equal, if a person’s utility increases, overall well-being will also increase. By choosing between other possible allocations, the welfare economy follows the cause of this allocation which maximizes a social welfare function of the type just described. One can easily verify that any allocation which maximizes such a welfare function is also Pareto-efficient.

Are there any institutional arrangements that we know of that are compatible with the emergence of effective Pareto results? Scholars familiar with Adam Smith’s “Invisible Hand” account of a market will immediately see a link between allocation ordered by a competitive market and Pareto efficiency.

Indeed, the content of the so-called first theorem of welfare economics is precisely that under certain well-defined conditions, a competitive equilibrium is Pareto efficient. (Secular interpretations of the theorem have led to lazy and inaccurate idealizations of the market as an institution.) But the first theorem, as Amartya Sen has pointed out, is entirely devoid of the kind of ethical meaning one would seek if there was an equal concern for the allocation caused by a competitive equilibrium. It is Pareto effective, but could well be deeply inegalitarian.

To see this, consider a two-person corporation in which Person 1’s share of the social dividend from an efficient allocation is a fraction x, and Person 2’s share is (1-x). If we increase x, person 1’s situation will be better, but person 2’s situation will be worse. If we reduce x, person 2 will be better off and person 1 will be worse off. In other words, there is no change in x, which can improve the situation for both people.

Equivalently, the result (x, 1-x) is Pareto efficient. But this must be valid for all x fractions. So there can be an infinite number of Pareto-efficient results (because there is an infinite number of x fractions), and welfare economics offers little prescriptive guidance for choosing between them. We will explore this question in a little more detail in a later article, with specific reference to Amartya Sen’s work in this regard. One of Sen’s most distinctive contributions to normative economics has been his critique of the theoretical foundations of welfare economics, a critique that exposes the inability of welfare economics to deal in a meaningful way. significant distribution problems. This, as we will see later, has a lot to do with the depleted and purely utility-based information upon which the welfare economy relies.

Let me conclude with a reading tip for anyone interested in exploring the issues noted above in more depth. A wonderfully lucid treatment of the subject under discussion is available in an essay written in 1975 by Professor Hal Varian of the University of California, Berkeley, entitled “Distributive Justice, Welfare Economics, and The Theory of Fairness.” , which was published in the journal Philosophy And Public Affairs, I took a lot of inspiration from Varian in writing this story, but there is no substitute for the original, which I highly recommend to the interested reader.

S. Subramanian is an economist, comments are welcome at [email protected]