Pareto efficiency

In game theory and economics, the concept of Pareto efficiency (or Pareto optimality) is a method to judge the efficiency of a set of decisions made by the participants. It was named after Vilfredo Pareto.

A set of decisions "x/y" (meaning that participant A chooses "x" while participant B chooses "y") is called Pareto optimal if there is no other state, other participants' prior and concurrent actions remaining the same, in which at least one participant can improve his own outcome.

If a participant can improve his outcome without harming anybody else, the new decision set Pareto dominates the old one.

An example

		B
		1	2
A	1	A: good / B: good	A: bad / B: very good
	2	A: very good / B: bad	A: OK / B: OK

In the case shown at the right side, participants A and B can choose between "1" and "2". The result can either be "very good", "good", "OK", or "bad".

The highlighted field ("2/2") is the Pareto optimal situation. All other situations can be improved.

For example, in "1/2" ("bad" for A, "good" for B), A could switch to "2". The result improves A's result to "good" while leaving B's result unchanged.

External links

• Pareto Efficiency by Peter J. Wilcoxen
• Definition of Pareto efficiency by Martin J. Osborne