Per Chappelow (2020), Pareto Efficiency implies resources are allocated in an economically efficient manner, that is, there is perfect competition and resources are used to the maximum level of efficiency, and no change can be made without making someone worse off. However, it does not imply equality or fairness, it only focuses on the efficiency of the allocation of resources, without considering whether the distribution of resources is just or not. (“Pareto Efficiency”)
Pure Pareto efficiency is just in theory, though the economy can move toward Pareto efficiency, called Pareto improvement.
Alternative Criteria For Economic Efficiency based on Pareto Efficiency
Making a decision whereby everyone gains without making at least one worse off is very difficult, and why alternative criteria of economic efficiency exist. Per Chappelow (2020), this includes:
Buchanan Unanimity Criterion: a change is efficient if all members of society unaminously consent to it.
Kaldor-Hicks efficiency: a change is efficiency if the gains to the winners of any chance in allocation outweigh the damage to the losers.
Coase Theorem: states that individuals can bargain over the gains and losses to reach an economically efficient outcome under competitive markets with no transaction cost (although, this is hard to do in practice).
Pareto Efficiency and Market Failure
A market failure is called a market failure, as in this situation, the market has failed to allocate optimally or efficiently. Thus, if any economy is prevented from reaching Pareto efficiency, a market failure exists- either by leaving an individual worse off or by resources being unspent. (Chappelow)
Pros of Pareto Efficiency
Pareto efficiency allows us to identify situations where resources are being wasted or under-utilised. It can be used to compare outcomes of proposed policies as well.
Cons of Pareto Efficiency
Pareto efficiency “does not consider moral distributions or equality across resource recipients.” Furthermore, Pareto efficiency assumes markets are perfectly competitive, however this is uncommon. Another is externalities: Pareto efficiency only considers those who are involved in the transaction, and not the effects on third parties (eg.: resource allocation causing pollution). Additionally, Pareto efficiency assumes zero transaction costs, which is also uncommon. Lastly, it is difficult to compare individuals (humans are complex, and moral/philosophical distinctions are hard to quantify).
Pareto Optimal In Game Theory
In game theory, an outcome is Pareto Optimal if an outcome cannot be improved upon without hurting at least one player. For example: if moving to another option hurts a player, it is not Pareto Optimal, but if it improves everyone’s situation, it is Pareto Optimal.
Example:
A cat owner has $30 which is currently unallocated and can:
1. Buy $30 of cat litter, and $0 to the cat toy
2. Buy some cat litter for $15 and $15 for a cat toy
3. Buy no cat litter and spend $30 on a cat toy
In this situation, every outcome is Pareto Optimal because the money would have otherwise been unallocated.
Consider another two options:
1. Spend $25 on cat litter and $15 on a cat toy
2. Spend $15 on cat litter and $0 on a cat toy
Option one is not Pareto efficient because only $30 is available and would mean another option (say groceries) would be worse off.
Option two is not Pareto efficient because resources are not utilised. The unspent $15 could have been used.
Works Cited
“Pareto Efficiency.” Tutor2u.net, 2025, www.tutor2u.net/economics/topics/pareto-efficiency?srsltid=AfmBOormH0IJAs7_aNB2PbYhOrCxx3VoEQG5GXLg-gpPiLYG1CsfIPCZ. Accessed 12 Feb. 2026.
Chappelow, Jim. “Pareto Efficiency.” Investopedia, 25 Dec. 2020, www.investopedia.com/terms/p/pareto-efficiency.asp.
