Answer to Question #195174 in Microeconomics for wtrv

Question

explain the difference between the concepts of pareto optimality and pareto improvement ,if policy change moves the economy from pareto situation to a non pareto optimal situation ,does this imply a deterioration in social welfare ?explain your answer and illustrate it with an Edgeworth box diagram .

Answer 1

Pareto optimality is a situation where if resources are reallocated, it will make one individual better and at least one individual worse. Although resources are distributed in an efficient economic manner, still equity and fairness is not shown. That is if economic changes are made to make an individual better off at least one is made worse off.

On the other hand in Pareto improvement, change in resource allocation doesn't harm anyone and helps at least one individual. Here, value is continually enhanced until Pareto equilibrium.

In terms of policy changes, when an economy is in a state of Pareto efficiency or optimality, social welfare is maximized in the sense that no resources can be reallocated to make an individual better off without making at least one individual worse off.

In the Edgeworth box diagram above, from C, two Pareto improvements can be made that is D and E which are the Pareto optimal. Once at this points, no Pareto improvements can be made. This implies that, when the economy is at the state D and E, the social welfare is maximized.