Pareto optimality (Maximum social welfare)

Usually, one thinks of efficiency as not being wasteful or getting the most out of the resources one has available. Economists offer the Pareto optimum—"a situation where no one can be better off without making someone worse off." Derived from the work of the Italian economist and sociologist Vilfredo Pareto, whose late nineteenth-century writings on political economy inspired much thinking about what made an economy efficient, Pareto optimality has come to mean making at least one person better off without making anyone else worse off. For an economy, it means that the allocation of resources is optimal if no other allocation exists wherein a person is better off and everyone is at least as well off. Economic theory holds that these conditions are met if consumers maximize utility, producers maximize profits, competition prevails, and information is adequate for the making of rational decisions. A free market unconstrained by government involvement, it is assumed, will achieve Pareto optimality by an invisible hand, that is, automatically, provided that production and consumption decisions do not entail substantial environmental disamenities. Imperfect market conditions, which include environmental disamenities on a large scale, challenge the assumptions of Pareto optimality and call for remedial measures such as pollution taxes or emission rights to restore market efficiency.

See also Externalities