What is a Pareto Improvement?
Under the rubric of neoclassical economic theory, a Pareto improvement occurs when a change in allocation harms no one and helps at least one person, given an initial allocation of goods for a set of persons. The theory suggests that Pareto improvements will keep enhancing value to an economy until it achieves a Pareto equilibrium, where no more Pareto improvements can be made.
Understanding Pareto Improvement
Named after Vilfredo Pareto (1848-1923), an Italian economist and political scientist also renowned for the Pareto Principle, a Pareto improvement in a macro sense is an action that leads to an economic benefit without making someone worse off. Given an initial allocation of goods or resources for a set of individuals, if a change in resources benefits at least one person while harming no one else, a Pareto improvement has been made. These improvements can continue to a point where the allocation is Pareto efficient - that is, when no more changes can be made to the allocation without making someone worse off. The goal of Pareto improvements is to make stakeholders satisfied instead of developing an efficient system or distributing resources equitably.
Pareto in Practice
Aside from applications in economics, the concept of Pareto improvements can be found in the fields of life sciences and engineering - in any academic discipline where trade-offs are simulated and studied to determine the number and type of reallocation of resource variables necessary to achieve Pareto equilibrium. In the business world, factory managers may run Pareto improvement trials in which, for example, they reallocate labor resources to try to boost productivity of assembly workers without decreasing productivity of the packing and shipping workers.
- A Pareto improvement is an improvement to a system when a change in allocation of goods harms no one and benefits at least one person.
- Pareto improvement is not considered an ideal method to measure improvements because it does not ensure equitable distribution of resources.
Pareto improvements, along with Pareto efficiency, are criticized in the realm of political economy because they do not address issues of welfare among different groups of people. Pareto improvements inform only steps to reach an efficient state, not necessarily an 'equitable' one that decision-makers in a democratic political economy strive to move society toward. If the wealthy class of a society is made better off without hurting the poor through a reallocation of a resource, then a Pareto improvement has been made. However, the economic status of the poor did not get better. A Kaldor-Hicks improvement improves upon the inefficiencies of Pareto improvement by making monetary transfers to make up for the difference in spending on development projects.
Example of Pareto Improvement
Suppose an equal amount of funds are disbursed to two families, one rich and another poor. The funds help lift the latter above the poverty amount but does not make much difference to the overall income of the former. This improvement is an example of Pareto improvement.
Another example of Pareto improvement is the case of two students exchanging lunchboxes. One of the students, who does not like cheeseburger, gives his burger to another student who considers it delicious. Even though one of the students gives away his burger, no one is worse off and both students are satisfied with the trade exchange. This is an example of a Pareto improvement.