[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

PARETO EFFICIENCY
In everyday usage, we say something is efficient if it involves little waste. Economists
relate the concept of efficiency to concern with the well-being of those in the economy.
When no one can be made better off without making someone else worse off,
the allocation of resources is called Pareto efficient, after the great Italian economist
and sociologist Vilfredo Pareto (1848–1923). Typically, economists’ use of the
term refers to Pareto efficiency. Saying that a market is efficient is a compliment. In
the same way that an efficient machine uses its inputs as productively as possible,
an efficient market leaves no way of increasing output with the same level of inputs.
The only way one person can be made better off is by taking resources away from
another, thereby making the second person worse off.
It is easy to see how an allocation of resources might not be Pareto efficient.
Assume that the government is given the job of distributing chocolate and vanilla ice
cream and pays no attention to people’s preferences. Assume, moreover, that some
individuals love chocolate and hate vanilla, while others love vanilla and hate chocolate.
Some chocolate lovers will get vanilla ice cream, and some vanilla lovers will
get chocolate ice cream. Clearly, this arrangement is Pareto inefficient. Allowing
people to trade resources—in this case, ice cream—makes both groups better off.
There is a popular and misguided view that all economic changes represent
nothing more than redistributions. Gains to one only subtract from another. Rent control
is one example. In this view, the only effect of rent control is redistribution—
landlords receive less and are worse off by the same amount that their tenants’ rents
are reduced (and the tenants are better off). In some countries, unions have expressed
similar views and see wage increases as having no further consequences than redistributing
income to workers from those who own or who manage firms. This view
is mistaken because it ignores consequences beyond the redistribution in each of
these instances. Rent control that keeps rents below the level that clears the rental
housing market does more than just take money out of the pocket of landlords and
put it into the pocket of poor renters. It affects the amount of housing that landlords
are willing to supply. It results in inefficiencies. For those concerned about renters
who cannot afford the going rate, there are better approaches, such as vouchers to
help those with low incomes pay for rent, that make the renters as well as the landlords
better off than under rent control. Thus, with rent control, the economy is not
Pareto efficient.
CONDITIONS FOR THE PARETO EFFICIENCY
OF THE MARKET ECONOMY
For the economy to be Pareto efficient, it must meet the conditions of exchange
efficiency, production efficiency, and product-mix efficiency. Considering each
of these conditions separately shows us why the basic competitive model attains
Pareto efficiency. (Recall the basic ingredients of that model: rational, perfectly
informed households interacting with rational, profit-maximizing firms in
competitive markets.)
222 ∂ CHAPTER 10 THE EFFICIENCY OF COMPETITIVE MARKETS