What is Pareto efficiency?

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:40

Pareto efficiency is most often used to refer to a state of the economy that allows society to extract the maximum possible utility from all available technologies and resources. At the same time, an increase in the share of any market participant necessarily entails a deterioration in the position of others.

A bit of history

For fairness, we note that "Pareto efficiency" as a concept did not arise from scratch. Back in 1776, the world-famous Englishman Adam Smith spoke of the existence of an invisible hand of the market, meaning by it a force that constantly directs the market towards a general equilibrium. Subsequently, this idea was finalized by the Italian economist V. Pareto, who added a criterion for the optimal distribution of resources to it.

Concept and application

The wording of this rule is quite simple: "Any change or innovation that does not harm anyone, that can benefit some people (in their own opinion), should be considered an improvement." Pareto efficiency has a very widemeaning. This criterion can be used to solve various system optimization problems in which it is required to improve some indicators, provided that the others do not worsen. In addition, Pareto efficiency is often used in a compositional approach to planning the development of economic systems, taking into account the interests of their constituent economic objects.

Note that there can be several final optimal states, and if they satisfy this rule, then any of them has the right to exist. All of them make up the so-called "Pareto set" or "the set of optimal alternatives". Since the formulation of the criterion allows any changes that do not bring additional damage to anyone, there may be quite a few such options, but in any case their number is finite. The situation in which Pareto efficiency is obtained is the state of the system in which all the benefits from the exchange are used.

80/20

When looking for optimal solutions, one more law, named after the Italian economist, should be taken into account. It's called the "80/20 rule". This Pareto principle, an example of which is found at every turn, says: "80% of the result brings only 20% of all the efforts applied to obtain it, and the remaining 80% of the work provides only 20% of the total result." How can this knowledge be applied in life? For example, there is a clear lack of free time (now almost everyone faces this situation). This means that we should single out those 20% of activities that are really important to us, andstop wasting your leisure time on 80% of all nonsense. In trade: most of the sales come from regular customers, which means that you need to build long-term relationships with customers. At home: We only wear 80% of our clothes 20% of the time – isn't it time to clean up your wardrobe?

If we add Pareto efficiency to this, we can draw the following disappointing conclusions, which we will have to put up with:

1. Most of what we do will not give us what we plan to get in return.

2. Expectations and reality rarely match. It's always worth making allowances for random factors.

3. High results can only be achieved through single actions.

So if something doesn't work, don't give up. It is impossible to resist the universal law. One has only to pause for a minute, draw conclusions, and then continue to act until the desired result is obtained.