What is Pareto efficiency?
It is also known as Pareto optimality or otherwise, social efficiency or economic efficiency. It is a state where the welfare of the people is said to have been maximised. There is no way that the society can be further better-off. The economy is already operating on the boundary of its frontier. The only way for a person or entity to become better-off is by having another person or entity becoming worse-off
What is Pareto improvement?
It is a process in which an economy is trying to further improve the overall well-being of its people. More technically, it is when an economic action leads to a further increase in overall utility whilst at the same time, no one is being made worse-off
Point D illustrates the idea of economic inefficiency/ Pareto inefficiency. This is because the welfare of the people/ society can actually be further increased when point D moves to point A or B. Members of the society are able to consume a greater combination of both goods and services. There is no opportunity cost between the two. The higher is the level consumption, the greater is the utility or satisfaction or well-being of the community in this case
Some practical examples of Pareto improvement:
a. Charitable activities can be considered as one. When Bill Gates gave away, say, $5 billion of his wealth to a charity fund or a very poor Sub-Saharan African (SSA) nation, he may get a joy and pride of doing so. At the same time, the recipient(s) may also get to benefit in the form of new roads, new houses, new schools, new hospitals and others
b. Instructing prisoners to carry out community service e.g. graffiti art and picking up litters is another good example. In the process, inmates may gain some self-esteem by being able to express their thoughts or show their soft-side. Members of the society gain in the form of cleaner environment and more beautiful sights. Taxpayers' money can also be utilised more meaningfully in this case
However, it is also worth noting that not all movements to the boundary of PPC can be treated as Pareto improvement. For instance:
a. The construction of new roads, railroads, schools and hospitals have tremendous economic benefits to the society e.g. higher actual and potential growth, more job opportunities, more tax revenue for the government and many more. However, this is not a Pareto improvement because in that process, some people will be inevitably made worse-off e.g. families and firms that have to be evacuated, loss of biodiversity, vocal environmentalists and others
b. The establishment of a free trade area/ trading bloc may lead to long-term efficiency gain. Regional growth and income will increase, people will have more choice, there will be more jobs with better pay, government finances improve, firms exposed to competition will become more competitive in future, free movements of labour will improve allocation of resources and many more. All these are the net economic benefits that no one can deny. However, this still cannot be classified as Pareto improvement. There are plenty of costs to be considered too e.g. demise of local firms/ industries that are unable to compete, more cases of structural unemployment, problems associated with migrants like lowering wages and 'stealing' jobs, worsening deficit and many more