Constrained Pareto efficiency
Encyclopedia
The condition of Constrained Pareto optimality is a weaker version of the standard condition of Pareto Optimality employed in Economics
which accounts for the fact that a potential planner (i.e. the government) may not be able to improve upon a decentralized market outcome, even if that outcome is inefficient. This will occur if he is limited by the same informational or institutional constraints as individual agents.
The most common example is of a setting where individuals have private information (for example a labor market where own productivity is known to the worker but not to a potential employer, or a used car market where the quality of a car is known to the seller but not to the buyer) which results in moral hazard
or adverse selection
and a sub-optimal outcome. In such a case, a planner who wishes to improve the situation is unlikely to have access to any information that the participants in the markets do not have. Hence he cannot implement allocation rules which are based on idisoyncratic characteristics of individuals, for example "if a person is of type A, they pay price p1, but if of type B, they pay price p2" (see Lindahl prices). Essentially, only anonymous rules are allowed of the sort "Everyone pays price p" or rules based on observable behavior; "if any person chooses x at price px then they get a subsidy of ten dollars, and nothing otherwise". If there exists no allowed rule that can successfully improve upon the market outcome, then that outcome is said to be Constrained-Pareto optimal.
Note that the concept of Constrained Pareto optimality assumes benevolence on the part of the planner and hence it is distinct from the concept of government failure
, which occurs when the policy making politicians fail to achieve an optimal outcome simply because they are not necessarily acting in the public's best interest.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
which accounts for the fact that a potential planner (i.e. the government) may not be able to improve upon a decentralized market outcome, even if that outcome is inefficient. This will occur if he is limited by the same informational or institutional constraints as individual agents.
The most common example is of a setting where individuals have private information (for example a labor market where own productivity is known to the worker but not to a potential employer, or a used car market where the quality of a car is known to the seller but not to the buyer) which results in moral hazard
Moral hazard
In economic theory, moral hazard refers to a situation in which a party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party insulated from risk behaves differently from how it would if it were fully exposed to the risk.Moral hazard...
or adverse selection
Adverse selection
Adverse selection, anti-selection, or negative selection is a term used in economics, insurance, statistics, and risk management. It refers to a market process in which "bad" results occur when buyers and sellers have asymmetric information : the "bad" products or services are more likely to be...
and a sub-optimal outcome. In such a case, a planner who wishes to improve the situation is unlikely to have access to any information that the participants in the markets do not have. Hence he cannot implement allocation rules which are based on idisoyncratic characteristics of individuals, for example "if a person is of type A, they pay price p1, but if of type B, they pay price p2" (see Lindahl prices). Essentially, only anonymous rules are allowed of the sort "Everyone pays price p" or rules based on observable behavior; "if any person chooses x at price px then they get a subsidy of ten dollars, and nothing otherwise". If there exists no allowed rule that can successfully improve upon the market outcome, then that outcome is said to be Constrained-Pareto optimal.
Note that the concept of Constrained Pareto optimality assumes benevolence on the part of the planner and hence it is distinct from the concept of government failure
Government failure
Government failure is the public sector analogy to market failure and occurs when a government intervention causes a more inefficient allocation of goods and resources than would occur without that intervention...
, which occurs when the policy making politicians fail to achieve an optimal outcome simply because they are not necessarily acting in the public's best interest.
See also
- Mechanism designMechanism designMechanism design is a field in game theory studying solution concepts for a class of private information games...
- Revelation principleRevelation principleThe revelation principle of economics can be stated as, "To any Bayesian Nash equilibrium of a game of incomplete information, there exists a payoff-equivalent revelation mechanism that has an equilibrium where the players truthfully report their types."...
- Pivotal mechanism
- Market for lemons