Vilfredo Pareto, Italian Economist Wilfredo Pareto Principle

Vilfredo Pareto (1848-1923) was a disciple of Walras and an early supporter of general equilibrium theory. He carried through the reasoning Walras used in general equilibrium theory and extended the analysis to consider the welfare implications of various policies. Pareto tried to extend Walrasian economics into policy. Pareto lays claim to being one of the fathers of modern welfare economics, the other being A. C. Pigou, who extended the welfare implications of Marshal-lian economics.

Pareto addressed the issue of how to evaluate the efficiency of resource allocation for an economy or for a particular market structure within an economy. Adam Smith had concluded that perfectly competitive markets resulted in desirable consequences, particularly higher long-term rates of growth for an economy. Increased interest in microeconomics, which began in the 1870s, led to questions concerning the efficiency of resource allocation and to the develop­ment of criteria for evaluating the merits of different economic policies that affect an economy.

Adam Smith's advocacy of laissez faire was not based on a theoretically rigorous model. It focused more on the macroeconomic consequences of markets coupled with a minimum of government intervention. In the 1890s, Pareto began evaluating microeconomic performance using the new marginal tools and be­came the father of the branch of welfare economics that works largely in a general equilibrium framework. Pareto also represents a continental (particularly French and Italian) approach, as opposed to the British framework based on the partial equilibrium structure laid down by Alfred Marshall. This British line of welfare economics began with Henry Sidgwick (1838-1900), a political philosopher who contributed to economics. Sidgwick published his Principles of Political Economy in 1883. It was Marshall's successor at Cambridge, Arthur C. Pigou (1877-1959), who became the father of the partial equilibrium branch of welfare economics by extending and refining Sidgwick's and Marshall's insights into market failures and externalities.

Pareto's answer to the question of evaluating the efficiency of resource allo­cation was straightforward: a change in resource allocation will improve welfare if one person can be made better off with no other person's being made worse off. An ideal or optimum distribution of scarce resources, a Pareto opti- mum, is defined as one in which it is impossible to make someone better off without making someone else worse off. Pareto recognized that his concept of optimality was not of particular relevance for real-world problems, and in his book Mind and Society (1916), he explained the necessity of making interpersonal compari­sons in real-world welfare analysis. However, he regarded his Pareto optimal criteria as a useful analytic extension of Walras's general equilibrium theory.

Pareto optimal policies acquired a special significance when it was determined that competitive markets will lead to a Pareto optimal position—a position from which no one can be made better off without making someone else worse off. This is one of the important conclusions that flowed from general equilibrium analysis, and it has deepened our understanding of markets. This judgment underlay the theoretical support of the market that was used in the formal aspect of the socialist-capitalist debate, which we consider in Chapter 13. But it missed important other aspects of the broader debate of the use of markets, and it made the market process seem mechanistic. In so doing, it directed welfare economics away from real-world issues and the use of economics as an engine of analysis, as Marshall wanted to use it, and toward a set of formalist deductive proofs that have little direct relationship to reality. The reality is that any policy helps some people and hurts others; thus, if economists are only to give favorable judgments on policies that fit the Pareto optimal criteria, they must separate their analysis from the real world.