Pareto Efficiency
Categories: Financial Theory
Your housemate came home...to you taking your first bite into a chocolate bar. You make eye contact. You know he loves chocolate. Awkward. You could give him some of your chocolate bar, but then you would get less chocolate than you had planned for. Dilemmas, dilemmas.
Good news: you don’t have to give up any of your chocolate. Just tell your housemate you’re being Pareto efficient, or Pareto optimal.
Pareto efficiency is when resources that are distributed to players can’t be moved without hurting at least one player. If you gave him some of your chocolate, sure, he’d be better off, but you’d be worse off. You’d only give him some if it didn’t detract from your payoffs.
Bad news: Pareto efficiency has nothing to do with fairness and everything to do with efficiency. Remember the production possibilities curve (PPC)? That’s where you have two goods you could make with the same inputs...like cookies and brownies. The curve shows all the options (cookie, brownie, etc.) where you’re fully utilizing all of your inputs. That makes all points on the PPC Pareto efficient.
The ideal Pareto efficient outcome is when everybody is better off working together. When the choice is obvious for both sides (like...both sides gain brownies), then it’s the Pareto efficient choice.
The trouble comes when players are incentivized to not cooperate. If there was one, lone brownie between you and your roommate, you both could share and get half each, one of you could grab it with the other getting nothing, or both of you grab it, and both of you get nothing since it ended up on the floor. This is why Pareto optimality is not Nash equilibrium.
In this brownie game, you might find that both of you go for it and grab it. Both of you are thinking “I’ll get the highest payoffs if I grab it first!” Too bad, since both of you grabbing it means neither of you get anything. Both of you grabbing would be a Nash equilibrium, where it doesn’t make sense for either of you to do any different. Both of you cooperating would bring you to a better place: a Pareto optimal place.
This is why Pareto optimal is sometimes associated with a “social optimum,” since it’s socially optimal in the sense that you can’t move any resources around without at least one player being worse off. If the resources weren’t distributed evenly to begin with, then this “social optimum” might not look fair, but it is Pareto efficient.
Life’s not fair, and neither is Pareto efficiency.
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Econ: What are Consumer Surplus, Produce...9 Views
And finance Allah shmoop What Our consumer surplus producer Surplus
and Alec A tive efficiency shmoop in economics Surplus happens
when you're getting more than you bargained for When the
sweet smell of surplus is in the air it means
somebody got a great deal either a consumer or a
producer If you're a consumer surplus means you paid less
for a good or service then you would have been
willing to pay For example let's look at a Karlis
pregnant city dweller whose water just broke Yeah since the
baby's saying It's Hypo time A mom's willing to pay
a lot of money for a new uber to the
hospital She might even be willing tio by the uber
car there She really rather not have her baby's first
sight to be that of a rat running into a
gutter with an entire slice of pizza sending the wrong
message You know but since it's just a normal of
uber ride on a normal day in normal time well
she ends up paying a normal price for that uber
ride to the hospital because the benefit she's getting is
much higher than the price she'd be willing to pay
for that ride She's reaping a consumer surplus on that
ride Well consumer surpluses that area on your typical supply
and demand curve right under the demand curve there but
above where the two curves cross like right in there
Which makes sense if you think about it the demand
curve which is also the marginal utility curve represent what
you're willing to pay for a thing right What seems
fair Anything above that line has you saying Hey man
what a rip off No way No way I'm paying
that much while anything below that line has you saying
Wow What a great deal Too good to pass up
if you ask me if your producer Well surplus means
you can get away with selling a good or service
for a higher price than you would have been willing
to sell it for Cha Ching Take virtual reality headsets
Well the first V R headsets were the only ones
on the market making them rare and you know super
hi tech gyms The sole producer of the V R
headsets capitalized on the V R hype and the rarity
of it all by setting prices is high much higher
than the price they needed to sell them at in
order to cover all the cost that went into making
them In layman's terms we might call this a price
mark up But people were willing to pay that higher
price to look like a blindfolded fool and enter other
realms So that's what the producers charged wouldn't you On
the supply and demand graph producer surpluses the area above
the supply curve which is also the marginal cost curve
but below where the two curves cross right in there
The actual line of supply curve is what producer willing
to sell their product for they won't sell anything below
the line since that would mean they wouldn't even be
covering their marginal cost like they'd be losing money on
every sale But selling above the line well thats extra
profits The higher producers can set their prices above their
marginal costs assuming consumers are willing to pay for it
Well the more profits the producer surplus They're reaping what
happened when Mohr companies started to make Mohr v R
headsets and there was competition in the marketplace with Mohr
v R Options on the market v R Headsets became
less rare When things to buy become more common prices
go down Yeah whereas one company making V R headsets
used to enjoy the make it rain monopoly power of
price setting multiple companies making V R headset makes the
market competitive When consumers air shopping around in comparing prices
producers turning to price takers that is they can no
longer sell their V R Headset said Well pretty much
any price they want at such high prices because consumers
will just go buy the same thing cheaper elsewhere Competition
makes producer surplus shrink and shrink away If the V
R headset market was perfectly competitive which would be all
the our headsets made by all producers were exactly the
same Well then producer surplus would pretty much completely disappear
meaning it was a total commodity market when both consumers
and producers feel like they're getting a fair shake or
a fair trade while money for v R headsets In
this case we have what's called Alec a tive efficiency
Well the elegant efficient point is we're supplying demand or
marginal cost and marginal benefit Cross consumers feel like they're
getting what they paid for not getting ripped off and
not getting a deal Producers are no longer rolling around
in beds covered in producer surplus money but they're not
losing money either When things were sold at analogue a
tive efficient level everybody's getting what they paid for no
more no less All the value is fair Which yeah
means that where their surplus there's inefficiency right If either
consumers or producers feel like they're getting a deal a
surplus while then the market isn't efficient Adam Smith's invisible
hand does its best to slap surplus out of the
markets with competition Making things fair for both sides doesn't
always work out that way But while the invisible hand 00:04:38.14 --> [endTime] you know does what it can