Crawl Across the Ocean

Thursday, March 26, 2009

6. Efficiency

Note: This post is the sixth in a series, Parts one, two three four and five

Efficiency is one of those words that causes trouble because it means different things to different people. Wikipedia has a pretty cool disambiguation page which lists just a few of the different interpretations available for this slippery word.

In order to tie down the meaning for the purpose of this series of posts, I want to use efficiency in one particular sense of the word which is what is known as 'Pareto efficiency'.

Parteo efficiency is the idea that if we have a situation where we could make some change that would make at least one person better off without making anyone worse off, then making that change would improve overall efficiency.

A situation is Pareto-efficient when there are no more changes that can be made that will make anyone better off without making someone else worse off.

The benefit of this type of efficiency is that, theoretically, it should be relatively easy to secure agreement to Pareto efficiency improvements since nobody has cause to object since nobody is being made worse off. Of course, to the extent we always compare our situation to that of others, anything that makes other people better off might make us feel worse off by comparison, even if our position is unchanged (in an absolute as opposed to relative sense) - but the question of what to do about envy is a tricky one that I’m going to ignore for now.

An example may help clarify what is meant by Pareto efficiency:

One of my childhood friends happened to have his birthday on the same day as Halloween. Naturally, a group trick or treat outing was incorporated as part of his birthday celebration. Afterwards, the group of us would pile into his bedroom and dump out our accumulated loot into a pile on the floor (one pile for each person - not one big pile). Note that at this point, the distribution of loot has been determined by the random allocations at each front door, and does not take into consideration each trick or treaters particular tastes. This raises the possibility of making trades that benefit all parties involved. For example, I always liked the Rockets and Mint Laura Secord bars the best, whereas others preferred items such as the Coffee Crisp that I had little interest in.

So the initial distribution was Pareto-inefficient in that changes could be made that would benefit people without making anyone else worse off.

So, naturally, we set about trying to achieve a Pareto optimal distribution of candy in a free wheeling round of candy exchange that would last until everyone was satisfied enough with their adjusted haul such that no further exchanges could be made that were agreeable to both parties.

We didn't necessarily always achieve such a distribution. After a while, when there might be a few useful trades still left we might declare that we were 'close enough' and move on. Or parents might intervene and cut short the trading since it was time for someone to go home.

Note that Pareto efficiency has little to say about ensuring a fair situation. For example, if one kid happened to miss out on the trick or treating for some reason and had no candy, there would be no Pareto efficiency gain from trading for them, since anyone trading with them would end up worse off since they had no candy to trade for (although, if a person gets a psychological benefit from the warm glow of charitably donating some of their candy to the unfortunate kid, then this could still be a win-win exchange).

Even if one kid somehow ended up with all the candy and everyone else had none, this could be considered a Pareto-efficient distribution since any change would make that kid worse off (assuming they were selfish enough not to feel bad about the unequal distribution, and the other kids were restrained enough not to simply take some of the lucky kids excess loot – these may be important assumptions!)

The next post should clarify why I felt it necessary to discuss the concept of Pareto efficiency before moving on...

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