Named after Italian sociologist and economist Vilfredo Pareto (1848-1923), Pareto efficiency is defined as the efficiency of a market which is unable to produce more from the same level of inputs without reducing the output of another product.
V Pareto, Manuale d’economia politico (Milan,1906)
Pareto efficiency or Pareto optimality is a situation where no individual or preference criterion can be better off without making at least one individual or preference criterion worse off or without any loss thereof. The concept is named after Vilfredo Pareto (1848–1923), Italian civil engineer and economist, who used the concept in his studies of economic efficiency and income distribution. The following three concepts are closely related:
- Given an initial situation, a Pareto improvement is a new situation where some agents will gain, and no agents will lose.
- A situation is called Pareto dominated if there exists a possible Pareto improvement.
- A situation is called Pareto optimal or Pareto efficient if no change could lead to improved satisfaction for some agent without some other agent losing or if there’s no scope for further Pareto improvement.
The Pareto frontier is the set of all Pareto efficient allocations, conventionally shown graphically. It also is variously known as the Pareto front or Pareto set.
Pareto originally used the word “optimal” for the concept, but as it describes a situation where a limited number of people will be made better off under finite resources, and it does not take equality or social well-being into account, it is in effect a definition of and better captured by “efficiency”.
In addition to the context of efficiency in allocation, the concept of Pareto efficiency also arises in the context of efficiency in production vs. x-inefficiency: a set of outputs of goods is Pareto efficient if there is no feasible re-allocation of productive inputs such that output of one product increases while the outputs of all other goods either increase or remain the same.:459
Besides economics, the notion of Pareto efficiency has been applied to the selection of alternatives in engineering and biology. Each option is first assessed, under multiple criteria, and then a subset of options is ostensibly identified with the property that no other option can categorically outperform the specified option. It is a statement of impossibility of improving one variable without harming other variables in the subject of multi-objective optimization (also termed Pareto optimization).