Home > Economics in Two Lessons > The most misleading definition in economics (draft excerpt from Economics in Two Lessons)

The most misleading definition in economics (draft excerpt from Economics in Two Lessons)

May 19th, 2015

After a couple of preliminary posts, here goes with my first draft excerpt from my planned book on Economics in Two Lessons. They won’t be in any particular order, just tossed up for comment when I think I have something that might interest readers here. I’ll update as I go, in response to comments and criticism; this may create some difficulties reading the comments thread, but hopefully the improvement in the final product will be worth it.

To remind you, the core idea of the book is that of discussing all of economic policy in terms of “opportunity cost”. My first snippet is about

Pareto optimality

The situation where there is no way to make some people better off without making anyone worse off is often referred to as “Pareto optimal” after the Italian economist and political theorist Vilfredo Pareto, who developed the underlying concept. “Pareto optimal” is arguably, the most misleading term in economics (and there are plenty of contenders). Before explaining this, it’s important to understand Pareto’s broader body of thought, one which led him in the end to embrace fascism.

Pareto and the libertarian path to dictatorship

Pareto sought to undermine the version of liberalism that dominated 19th century economics, according to which the optimal (most desirable) economic outcome was the one that contributed most to human happiness, often (if somewhat loosely) summed up as ‘the greatest good of the greatest number’. Particularly as developed by the great philosopher and economist John Stuart Mill, this is a naturally egalitarian doctrine.
The egalitarian implications of the classical framework reflect the fact that the needs of poor people are more urgent than those of the better off. So, the happiness of the community as a whole all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be social desirable and that large accumulations of individual wealth, which contribute only marginally to the happiness of a small number of people are undesirable in themselves, though they may in some circumstances be a by-product of desirable policies.
Pareto’s big achievement, further developed by a large number 20th century economists, was to show that much of economic analysis could be undertaken without invoking the concept of utility. Hence, interpersonal comparisons of happiness, which invariably lead to the conclusion that redistributing wealth more equally is beneficial, could be dismissed as ‘unscientific’.
Pareto didn’t stop with an attack on the economic implications of Mill’s approach. Mill’s philosophical framework implied support for political democracy, including the enfranchisement of women. Since everyone’s welfare counts equally in the classical calculus, the political process should, as far as possible, give everyone equal weight.
Pareto reversed this reasoning, arguing that a highly unequal distribution of income was both inevitable and desirable; he proposed what he called a power law, described by a statistical distribution which also bears his name. Pareto’s “Law” may be summed up the 80-20 proposition, that 20 per cent of the population have 80 per cent of the wealth.
The supposed constancy of income distribution implies that any attempt at redistribution must be essentially futile. Even the aim is to benefit the poor at the expense of the rich, the effect will simply be to make some people newly rich at the expense of those who are currently rich. Pareto called this process ‘the circulation of elites’. (In his dystopian classic 1984, Orwell has the Trotsky-like character Emmanuel Goldstein present the same idea as the starting point of The Theory of Oligarchical Collectivism. Orwell almost certainly derived the idea from James Burnham, an admirer of Pareto whose work Orwell saw as the embodiment of ‘power worship))
All of this led Pareto to become one of the first advocates of a political position combining an extreme free-market position on economic issues with hostility to political liberalism and democracy. Pareto welcomed the rise of Mussolini’s fascist regime, and accepted and accepted a “royal” nomination to the Italian senate from Mussolini. However, he died in 1923, less than a year after
Pareto was not really a fascist however. Rather, he developed a version of liberalism similar to that of his more famous successors, Hayek and Mises, both of whom embraced and worked for murderous regimes that had come to power by suppressing democratic socialist parties. Like Pareto, neither Hayek nor Mises can properly be described as fascists – they weren’t interested in nationalism or in the display of power for its own sake. Rather, their brand of liberalism was hostile to democracy and indifferent to political liberty, making them natural allies of any authoritarian regime which adheres to free market orthodoxy in economics. (Fn Supporters of Hayek and Mises commonly describe themselves as “libertarians”, but their alliance with brutal dictators makes a travesty of the term – they have been derisively described as “shmibertarian”).

Pareto optimality

Now back to “Pareto optimality”, and why it is such a misleading term. Describing a situation as “optimal” implies that it is the unique best outcome. As we shall see this is not the case. Pareto, and followers like Hazlitt, seek to claim unique social desirability for market outcomes by definition rather than demonstration.

If that were true, then only the market outcome associated with the existing distribution of property rights would be Pareto optimal. Hazlitt, like many subsequent free market advocates, implicitly assumes that this is the case. In reality, though there are infinitely many possible allocations of property rights, and infinitely many allocations of goods and services that meet the definition of “Pareto optimality”. A highly egalitarian allocation can be Pareto optimal. So can any allocation where one person has all the wealth and everyone else is reduced to a bare subsistence.

Recognising the inappropriateness of describing radically unfair allocations as “optimal”, some economists have used the description “Pareto efficient” instead, but this is not much better. It corresponds neither to the ordinary meaning of “efficient” nor to the meaning with which the term is commonly used in economics, which is also misleading, but in a different way.

The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.

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  1. Newtownian
    May 19th, 2015 at 19:11 | #1

    Reading this explanation of Pareto v. Mill I am struck by the extreme/contrasting nature of their ideals
    – elites receiving and perpetuating a privileged position and wealth acruing as ‘natural result’ v.
    – redistribution benefiting the poor at the expense of the rich ? presumably leading eventually to everyone receiving the same share.

    Neither option seems an ideal basis for assigning the fruits of society in an fair and sustainable manner.

    The rise and circulation of privileged capitalist elites is simply obnoxious as unlike in Randian mythology such wealth in reality more stems from power, sneakiness, birth, opportunistim, psychopathy and plain simple luck as much as any inherent deserving nature. The real best of the best are generally well off, using Nobel Prizes as a metric, but are also notable with dishonorable political exceptions (e.g. Kissinger) with having no overlap with the Forbes list of billionaires whatever. The lack of credibility on average is confirmed by the obscene fetishes and arrogance of many of the latter. The genuine rich philanthropist appears to be as much a minority as rational individuals in the current US Republican Party’s presidential candidate list.

    At the other extreme egalitarianism is also based on a myth – people are simply not equal – in their potential, their ability to do good, their personal attributes, their intelligence, their ability to make sensible decisions. These differences are is simply an outcome of people being enormously variant thanks to genetics, epigenetics, their economic social and physical environment, shear dumb luck and how these factors come together and changes in the path they tred. Thus we have the move to equal opportunity rather than equal shares.

    These contrasting alternatives arise I suggest from the promotion of single life careers with rewards accruing according to supply, demand, status, remuneration and closed shops, and increasingly less the old ideal of the pursuit of wisdom. As a result you get some brilliant specialists. But this system also and arguably promotes the greedy and vainglory to accentuate their personality defects while more ordinary people are locked into careers which bore them witless or distort their humanity. Overall this system operates in pursuit of an even cruder idea of ‘efficiency’ reflecting increasingly the Fordism/Taylorism embedded in much management theory.

    In preindustrial times the utilitarianism underlying career specialization, made sense so societies could move beyond widespread poverty and famine risks. But does it make sense today in a post industrial service society increasing dominated by poorly paid insecure and make work jobs – MacDonalds, the finance ‘industry’ whose main justification is making of monetary profit. The answer seems no to me. There is still essential/invaluable work out there – tending the old and invalid and including them in society rather than locking them up in nursing homes, cleaning restoring and rewilding the environment e.g. through land and biological community restoration. But these tend to be poorly paid, work for the dole or voluntary with low status by virtue of the people doing them being poorly or not paid at all.

    Maybe its time to change the system to one which promotes/embeds not just equal opportunity but also unberudgingly provides a security baseline reflecting ALL of Maslow’s human needs.

  2. hc
    May 19th, 2015 at 19:39 | #2

    Inessential change “optimal” to “efficient” and the term is both useful and a foundation for economic policy since it embodies a search for non-wastefulness. Economic policy is concerned with equity and (Pareto) efficiency. Get rid of wasteful deadweight losses to maximise the pie and distribute the maximized pie equitably. Sounds a sensible prescription to me. If you can make approximately non-distorting transfers then do so and then rely on the First Theorem to achieve efficiency alone. If you can’t make the transfers in a non-distortionary way then pursue efficiency but consider the equity consequences simultaneously.

    Whatever Pareto’s political views it is difficult to understand how we could have anything resembling public economics or environmental economics without the highly useful idea of Pareto efficiency. Try not to be wasteful.

  3. Ivor
    May 19th, 2015 at 20:01 | #3


    A feudal society would be Pareto efficient if you cannot make the Lord richer without making at least one other person worse off.

    A slave society would be Pareto efficient if you cannot make the masters richer without making a least one other person worse off.

  4. May 19th, 2015 at 21:08 | #4

    While I would hardly defend Pareto himself, or the way in which many economists have used his ideas, I think the concept of Pareto efficiency, or at the very least Pareto domination, is still useful. In a general sense, I think it is reasonable to say that the ideal allocation of goods is Pareto optimal, assuming that Social Welfare is increasing in individual welfare. That said, I think that this element of social desirability is hugely over-emphasised, in part because of its ideological ramifications (and the neo-liberal obsession with “efficiency”) and in part because it is mathematically neat for undergraduate students. This is certainly something that needs to be rectified, but I do not think it involves removing the concept of Pareto efficiency.

    Secondly, and I think more importantly, Pareto efficiency provides a very useful mechanism for talking about changes from the status quo, in that it doesn’t require controversial statements about the distribution of beneficial economic changes. While obviously distribution is very important in other places, and questions of distribution deserve even more emphasis than they currently have, I think that showing a project or allocation is a Pareto improvement on a current allocation is helpful in determining and justifying public policy. A clear example might be the taxing of externalities: with the Carbon Tax (or a congestion charge), it may be possible to redistribute the proceeds to ensure that no one is worse off and some people are better off as a result of less global warming or less traffic. While this is clearly imperfect (no one is taking into account future generations or the planet), it does help to separate the questions of equity and principle from those in deadweight loss and, where necessary, make reasonable improvements far less controversial.

    I guess, in sum, what I’m saying is this: we shouldn’t let the fact that people are reluctant to engage with equity, democracy and liberalism stop us from using an otherwise useful concept

  5. Megan
    May 19th, 2015 at 21:14 | #5

    I picked up an old book at the Lifeline bookfest last weekend, “The AMPOL book of Australiana”.

    It is a layperson’s guide to trivia/facts & figures and this edition was 1964.

    Back then, Australia’s population was about 11,000,000 and it says that in 1963/4 the top 0.1% of taxpayers had an income above 10,000 pounds annually.

    By my rough reckoning 10,000 pounds in 1964 is about $300,000 in today’s money. Not bad, but according to a recent article in the SMH the top 0.1% today earn above about $688,000.

    Just 59 people out of 11,000,000 had an annual income above 50,000 pounds (or $1.5 million in today’s money).

  6. Megan
    May 19th, 2015 at 21:27 | #6

    PS: The book was only available through AMPOL petrol stations.

    AMPOL was an Australian owned petrol retailing company started by a group of individuals concerned about high petrol prices in the 1930s and particularly concerned about gouging and transfer pricing (OK, they were probably mostly concerned about getting a piece of the action).

    The managing director was Sir William Gaston Walkley (1896-1976), after whom the journalists’ lovefest awards are named.

    Apt really.

  7. Robertito
    May 19th, 2015 at 21:43 | #7

    @Ed Penington
    But doesn’t the vast majority of public policy involve decisions that are not Pareto improvements? “Were going to take money from you to pay for the education of someone else’s children” is the opposite of a Pareto improvement (which is what, Pareto disimprovement?), but it’s at the heart of Australia’s political system. In fact, is this reliance on the notion of Pareto improvement the reason why it seems we’ll never again get a genuine, bona fide tax rise?

    So I think if the Quigginator’s point is that we need to place less emphasis on it, that seems fair enough. As a student of economics and a tutor of first years, I’m increasingly aware that first year is the highest level of economics education most of our students get. Should we be wasting these precious few hours of instruction on shakey pure theory ideas like Pareto optimality, or on something that is more useful, messy and honest about its political purposes?

  8. Collin Street
    May 19th, 2015 at 22:13 | #8

    There are no pareto improvements because some people value the knowledge that others are badly off.

  9. May 20th, 2015 at 00:32 | #9

    So an important idea with Pareto improvements is obviously that you could (if you wanted) compensate everyone and leave no one worse off, even though you would never actually do that. To me, that is pretty clearly the case with school education, in that there are pretty big levels of market failure, myopia etc. In that sense it remains a useful way of thinking about public policy, in that if you take on any project which could be a Pareto improvement (after redistribution), then it will even out that people on the whole are better off.

    As you rightly point out, though, it is a bit strange that we focus so much time on a concept that is a minor part of what a truly good distribution of goods should look like. My only defense would be that it provides a very useful baseline for analysing more specific forms of market failure divorced from their context of equity etc. For example seeing the effects of asymmetric information or non-excludability in public goods, the principle of “everyone at least as well off, someone better off” is a very simple and unassuming way of showing how a market can fail.

  10. nick j
    May 20th, 2015 at 01:42 | #10

    how is opportunity cost calculated? the only time I’ve come across the concept is it’s use as a fiddle factor in accounting.

  11. Brian
    May 20th, 2015 at 03:10 | #11

    If this is aimed at the layman, I think that a clarification of what opportunity cost means should be there. In my world of entrepreneurship, opportunity cost is the thing(s) you cannot do because you are spending your limited time doing other things. It is, in that definition, a function of time and human energy and skill applied to problems. For instance, if I spend time working on a crowd-funding campaign for an infant measles vaccine, then I won’t have that time to spend on other things. (A current example.)

    In the real world, opportunity cost by this definition can be hard to know, because most things are more involved than they appear to be at first, and the rewards of doing a particular thing are not known ahead of time. The success or not of a campaign rests on factors that cannot be predicted – public perception, vagaries of news editors, how a story gets written, whether anti-vax people decide to attack it hammer and tongs, etc. So, that choice may not really be the highest reward. In that sense, opportunity cost is another abstract fiction that we can agree probably exists, but like optimal price, what it is depends on assumptions that may not be true.


    I also think that Pareto optimal/efficient is still fairly opaque after reading. Many educated laymen are familiar with the Pareto chart. For instance, anyone who works in quality control in a factory has probably heard of it and may use it. (I know this isn’t what you are talking about, but it has some relationship.)

    I think what you are getting at is that for any distribution of income, if you change allocation, someone will always suffer. This appears to be tautology, and a hole in his thinking. I know you didn’t use this, but I think that if Pareto found 80% of the peas in his garden in 20% of the pods, he had a soil problem, he was harvesting at the wrong time, or harvesting immature pods along with mature ones. That’s not normal, and may be a way to illustrate how sloppy some of Pareto’s thinking was.

    Anyway, some more exampled discussion, and clarification of what the hole(s) in Pareto’s logic are would be good. I am reminded of nothing quite so much as when I was working on a government funded project, and we found ways to justify choosing the vendor that was desired, by working on the numbers. Except our efforts were much more involved and sophisticated than Pareto’s.

  12. Stephan
    May 20th, 2015 at 05:42 | #12

    the problem I’ve always had with Pareto optimization is that it *is* utilitarian; its utility is linear. That is, the value of a unit of currency to a rich person is exactly the same as the value to a poor person. I would have no problem with a nonlinear Pareto optimization, using the (experimental) utility function (which would be a lot closer to a log function than linear). That one change would have enormous effects on a number of theorems.

  13. Matt
    May 20th, 2015 at 09:27 | #13

    The egalitarian implications of utilitarianism reflect the fact that the needs of poor people are more urgent than those of the better off. So, aggregate utility all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be social desirable and that large accumulations of individual wealth, which contribute only marginally to the happiness of a small number of people are undesirable in themselves, though they may in some circumstances be a by-product of desirable policies.

    The counterclaim will presumably be that even those poorest members of the community are better off under their preferred distribution than they would be under some other distribution. This seems to be a standard modal claim in defence of systems that produce a lot of wealth inequality. It might be the case that the policies that produce such inequality nevertheless leave the poorest better off than they would be under some less-unequal distribution. Maybe that claim isn’t true, but I think it needs to be addressed – does the set of policies that leads to extreme inequality produce more growth even at the bottom of the distribution than a more redistributive set of policies?

    The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs.

    Some of what you write, including this section, makes me think that you’re conceptualising opportunity costs in terms of a comparison between time1 and time2 – could we change a policy such that at time2 some people would be better off than they were at time1? When I think of opportunity cost, I think of a comparison between world1 and world2 – the opportunity cost of a policy is (roughly) the difference in utility between world1 and the most preferable possible world in which the policy is different.

    Of course the standard objections to utilitarianism remain – harvesting organs from one healthy person to save five others, keeping a small number of slaves to make the majority much happier, etc.

  14. Uncle Milton
    May 20th, 2015 at 09:37 | #14

    there are infinitely many possible allocations of property rights, and infinitely many allocations of goods and services that meet the definition of “Pareto optimality”

    What’s your point John? This is just the second fundamental theorem of welfare economics which Arrow proved in the early 1950s. Or if you want to go back earlier, the market socialists of the 1930s argued that you get all the benefits of a free market and an egalitarian society by first redistributing wealth as equally as desired. Of course later theory (especially from Stiglitz) and practice (in places like Hungary which tried some market socialism) showed it’s not that simple.

    No economist, as an economist, is going to argue that existing redistribution of wealth is desirable, let alone optimal, unless they add some auxilliary political argument from Nozick or someone like that. Many right wing economists do just that. But that is them being right wingers, not economists.

    All of this has been known for decades.

  15. Uncle Milton
    May 20th, 2015 at 09:41 | #15


    Indeed, the whole argument for a carbon tax compared to “direct action” is based on the idea of Pareto efficiency.

  16. James Wimberley
    May 20th, 2015 at 11:53 | #16

    The concept of Pareto efficiency is interesting and colder be useful, but I fera that JQ is right that it has become the excuse for a grand trahison des clercs.
    An example of the distorsion is the EU Commission’s obsessive pursuit of short-run efficiency in the market for renewable electricity at the neglect of their growth and cost reduction, which are far more important. Germany was pressured into replacing its very successful solar FITs with auctions for larger plants, a completely pointless victory unless you are a middleman.

  17. J-D
    May 20th, 2015 at 12:29 | #17

    I can grasp how a recommendation to achieve Pareto-optimality (or Pareto-efficiency) differs from the common utilitarian recommendation of achieving maximum aggregate utility.

    But I don’t grasp how the actual concept of Pareto-optimality (or Pareto-efficiency) can be meaningfully defined independently of some equivalent of the concept of utility (although not necessarily using that term explicitly). The definition of the concept depends on its being meaningful to talk about making individuals better off and making individuals worse off, but this postulates being able to compare states/conditions/outcomes for an individual, at least qualitatively if not quantitatively, and I don’t grasp how this differs from postulating a measure of utility, even if defined only by individual preference. ‘I prefer A to B’ is equivalent to ‘A has more utility for me than B’, in the sense in which utilitarians use the term ‘utility’.

    I do grasp the difference that utilitarians may need a definition of utility as quantifiable in order to make the notion of aggregate utility meaningful, whereas this is not essential to definition of the Pareto concept — is this all? Do users of the Pareto concept discuss how they’re defining ‘better off’ and ‘worse off’? Do they do it in a way that deals with the issue of quantifiability?


    It seems to me that nearly all actually obtaining states of affairs (as opposed to hypothetical ones) will be either Pareto-optimal/Pareto-efficient or very nearly so or rapidly converging on that status: because in proportion as a change benefits some there will be pressure in favour of it, and if it costs nothing (to anybody) there’ll be no pressure against it.

    I grasp that conservatives may argue that if current arrangements are Pareto-optimal/Pareto-efficient there’s no decisive case in favour of change, but from an impartial point of view how that does that carry any more weight than the converse argument that if proposed new arrangements are also Pareto-optimal/Pareto-efficient, there’s no decisive case against change? In an economy based on slavery, for example, it may be true (let it be conceded for the sake of argument) that there’s no way to make some (such as the slaves) better off without making others (such as the slave-owners) worse off; but once slavery has been abolished, it will still be true (almost certainly) that there’s no way to make some better off without making others worse off. For making choices the Pareto concept seems a hopelessly weak evaluative criterion.

  18. John Quiggin
    May 20th, 2015 at 17:24 | #18

    “All of this has been known for decades.” Of course it has. If I were claiming to be discovering such a major result, I wouldn’t be doing it in a quasi-textbook, let along a blog preview of one. I’m not claiming to have invented the Second Welfare Theorem, just restating it in terms that (I hope) readers can understand, and without scary words like “Theorem”.

    The only thing for which I will claim some limited novelty is the final sentence of the post.

  19. John Quiggin
    May 20th, 2015 at 17:26 | #19

    @Uncle Milton

    Indeed, the whole argument for a carbon tax compared to “direct action” is based on the idea of Pareto efficiency.

    I’ll be making this same argument in terms of opportunity costs.

  20. My2c
    May 20th, 2015 at 18:00 | #20

    Delighted to have stumbled upon a blog that promises to provide such a healthy supply of good brainfood (even the fascinating trivia tidbits in the comments – thank you @Megan.

    I would say I’ m regarding the specifics of the post, it sounds like the Pareto theory could be bunkum but I had trouble following the attempt to express the equilibrium in terms of opportunity cost. I’m now off to refresh on the opportunity cost concept. I do realise given “the core idea of the book is that of discussing all of economic policy in terms of “opportunity cost””, that before getting to the chapter on the Pareto Optimality, one would have already had that refresher.

  21. James Wimberley
    May 21st, 2015 at 06:22 | #21

    “It seems to me that nearly all actually existing states of affairs will be Pareto-optimal or nearly so ..” This is the famous Chicago theorem of the impossibility of the $100 note in the road. Real economies exhibit wide variations between best and worst practice. That is how real businessmen make money. There are even wider differences between countries. No patents prevent Nepal from adopting the best US technology of 1990. Learning to do things better is hard, and can’t be done in isolation.

  22. J-D
    May 21st, 2015 at 07:49 | #22

    @James Wimberley

    I get the impression that you think you’ve produced examples that indicate my estimate was incorrect, but you haven’t. True, people make money out of the difference between best and worst practice, but if anything that tends to confirm my point rather than the reverse. If there were no difference between best and worst practice that might make some people better off, but the people who were prevented from making money from the difference would presumably be worse off. If it’s true that the lack of patents prevents Nepal from adopting the best US technology of 1990, is there any way of changing that without making some people worse off?

    Remember, the definition of Pareto-optimality/Pareto-efficiency is not ‘no way to make people better off’ but ‘no way to make somebody better off without making somebody else worse off’. To show an exception to this it is insufficient to show ways to make people better off. To show an exception you need to show examples of ways to make (some) people better off that do not make anybody worse off, and this you have not done.

    Think again of the example I gave earlier, of slavery. (Just in case there’s any lack of clarity, I emphasise that I am against slavery.) It’s obvious that if slavery exists it’s easy to find a way to make people better off: free the slaves. But freeing the slaves would make some people worse off, the slave-owners. (Again, in case there’s any lack of clarity, I am not asserting that this is a reason not to do it!) So the existence of slavery is compatible with Pareto-optimality/Pareto-efficiency.

    But note that likewise the banning of slavery is compatible with Pareto-optimality/Pareto-efficiency! In our current situation, where slavery is not legal, we could make things better for some people by allowing them to enslave others, but only at the cost of making the people enslaved worse off. (Again, for clarity, I am not advocating this!)

    Both slavery and the banning of slavery are compatible with Pareto-optimality/Pareto-efficiency! Is there anything that isn’t? Is poverty in Nepal resulting from lack of access to patented technology compatible with Pareto-optimality/Pareto-efficiency? Yes, it is, if the change needed to get rid of it would make somebody — anybody — worse off. ‘Learning to do thing better is hard, and can’t be done in isolation’, you write, but that is effectively equivalent to saying that improvements for some can only come at a cost to others, which is in turn equivalent to your affirming that the criterion of Pareto-optimality/Pareto-efficiency is met.

    In case it wasn’t clear, my position is not that the Pareto criterion is always met and that this is a good thing. My position is that the criterion is always met (or close to being met) and that therefore the criterion is practically useless.

  23. hc
    May 21st, 2015 at 08:08 | #23

    John, You can probably, with some work, identify the idea of wastefulness using the idea of opportunity cost but what a backward step that would be. For example, isn’t it much easier to explore the consequences of a pollution externality using the idea of Pareto inefficiency and DWLs? Not only do you get a measure of the scale of the inefficiency but side results as well – e.g. that the good is underpriced and being produced in excess. Or consider a pure public good that is being under provided by markets – again much easier to identify the inefficiency here via the concept of Pareto inefficiency than using idea of opportunity cost. A bit confused at what you are trying to do? Is it to debunk the market model?

  24. Ikonoclast
    May 21st, 2015 at 09:05 | #24

    Can a complex theory convince the mass of people? Complex theories in physics and chemistry (to name two fields) can convince people because of the powerful physical demonstration effects of correct theory. It is not the equations that convince people. It’s the cars, TVs and atom bombs.

    Can a complex, correct socioeconomic theory convince people or will they be more likely to accept simplistic and incorrect theory? Incorrect, simplistic theory in this arena can muster great propaganda and demonstration effects of its own, at least by misattribution . Causes and effects are much more difficult to attribute correctly when dealing with “wicked problems”.

    This suggests to me that all hopes for intellectual solutions to political economy controversies are misplaced. What has to happen is the working out in practice. Thus, for example, capitalism cannot be theorised out of existence nor theorised into perpetual existence. Now that it is an extant system, in all its impure real forms, its efficacy and sustainability will be continually tested in empirical reality. Only empirical reality will tell us if it is efficacious and sustainable in the long term.

    Some may have their theories (like me). These theories can predict events (correctly or incorrectly) but never direct events. Theory can only direct events (produce desired effects by putting theory into practice) when the cause-effect mechanism is simple, direct and obvious. The conditions of simple, direct and obvious are not met for wicked problems like the socioeconomic system.

  25. Uncle Milton
    May 21st, 2015 at 09:05 | #25

    @John Quiggin

    The term opportunity cost was coined by the Austrian economist Friedrich von Wieser (says Wikipedia). He appears to have had some questionable (though maybe not by central European standards of the time) questionable political views of his own – “freedom has to be superseded by a system of order.”

    And, irony or ironies. he disciples (Wiki’s word) were Hayek and von Mises.

    If the objective is to replace displace Pareto optimality because of Pareto’s politics, you want to be sure that what gets put in place is better, on those terms.

  26. John Quiggin
    May 21st, 2015 at 10:38 | #26
  27. anthony nolan
    May 21st, 2015 at 17:29 | #27

    JQ: I’ve been economics averse since reading Das Kapital, all three volumes, and then Ricardo, Smith, Bentham, Malthus, Locke, Bentham. I could go on. I never read anything from economists thta had the explanatory power of Marcuse and the rest of the Frankfurt School, Habermas and Honneth in particular.

    So, thanks for the plain lingo intro to the current orthodoxy in economics. I have ignored that dialogue to my own peril.

    However, if you don’t mind, you appear to me to be approaching the entire field from a first principles basis without going dep enough into the matter of ‘what are the first principles?’

    I suggest that what stalks your approach is the idea of the market. I could provide a summary of the problems but in this instance offer instead the ideas of Claus Offe: who reasonably asserts that ‘markets’ are nothing supernatural, they are not even natural, rather, they are the superstructural encrustations of human institutions and all of the classed, monied, gendered, ‘raced’ and powered relations that went into their construction in the first instance.

    That they are meerly the products of human culture and activity is the key to understanding that their current forms are contingent, specific and malleable. They contain as much truth about the human condition as the beliefs of the belief system that extinguished itself on the Easter Islands.

    Surley rationality can defeat this insanity but only by cleaving to its principles which excludes reifying multitudes of meaningless interctions as a ‘market’ consciousness.

  28. Ernestine Gross
    May 22nd, 2015 at 00:34 | #28

    1. “.. core idea of the book is that of discussing all of economic policy in terms of “opportunity cost”.

    2. ” The situation where there is no way to make some people better off without making anyone worse off is often referred to as “Pareto optimal”

    Factual situation: V. Pareto (wealthy) married a Russian woman (said to have been peniless) who later left him for a servant. Divorce was not possible for legal reasons.

    How would you describe this situation in terms of opportunity costs?

    3. “Now back to “Pareto optimality”, and why it [1 above] is such a misleading term. Describing a situation as “optimal” implies that it is the unique best outcome.”

    Pareto might agree with you regarding [1] being misleading because, according to Maurice Allais:
    “Pareto defined a situation of maximum efficiency (1906, chapter 6, sec. 33, and Appendix, sec. 89; 1911a, sec. 28) as one in which it is impossible to increase the index function of one individual without decreasing that of some other individual. According to this definition, a situation of maximum efficiency is one in which any index function is a maximum subject to (a) the condition that the index functions of the other consumers be maintained at given levels and (b) the ruling production functions.”

    Allais notes and discusses the similarity to Edgworth’s work on index functions.

    [Source: Maurice Allais, http://www.encyclopedia.com/topic/Vilfredo_Pareto.aspx%5D

    PS: J.S. Mill as well as his father, James, worked for the East India Company during colonial times. Does this mean they ’embraced’ colonialism? (I don’t know. I assume they had to make a living because, in contrast to Pareto, they were not born into wealth, but, not unlike described by Pareto, in his circulation of elites, worked very hard as described in J.S. Mill’s autobiographical note. Pareto had the means to do what he wanted, including switching from engineering to economics, collecting statistics on the distribution of land ownership in Italy and then wealth distributions over time and space and then to social systems. He could afford, financially, to ignore his place in the social pecking order for the apparent pleasure in observing what is going on and exploring the limits of scientific methods in social sciences.)

  29. J-D
    May 22nd, 2015 at 07:51 | #29

    @Ernestine Gross

    ‘Factual situation: V. Pareto (wealthy) married a Russian woman (said to have been peniless) who later left him for a servant. Divorce was not possible for legal reasons.
    ‘How would you describe this situation in terms of opportunity costs?’

    Is this a trick question?
    For Pareto, the opportunity cost of getting married was that he gave up the opportunity of continuing his lifestyle as a single man.
    For his wife, the opportunity cost of leaving him was that she gave up the opportunity of continuing her lifestyle as his wife.
    For the legislators, the opportunity cost of maintaining the divorce laws was that they gave up the opportunity of giving people access to divorce.

  30. May 22nd, 2015 at 12:41 | #30


    I agree that Pareto optimality is a highly misleading concept, one that has been much misunderstood and abused by economists to advance policies they could not otherwise defend. And you are right that efficiency does not tell us much if anything about what states of affairs we should prefer. If your book can do something to expose the inconsistencies and illogic, then I look forward to buying a copy.

    It might be that economists are more wrong about welfare economics than anything else. For example, as economists define it, inefficiency might be preferable to efficiency. Problems like the one you discuss are abundant in welfare economics.

  31. Ernestine Gross
    May 22nd, 2015 at 16:41 | #31

    I believe it is now established that V. Pareto did not undermine ‘utility’ (in the sense of ‘satisfaction’, which poetically may be called happiness), nor ignore it. As for later authors, G. Debreu proved that under specified conditions on ‘preferences’ (ordering of alternatives), a utility function with specified properties is obtained. All this, however, does not exclude the possibility that the zombies re-surrected their religion without having read either J.S. Mill or V. Pareto and in particular none of the authors from Keynes onward.

  32. Nicholas Gruen
    May 23rd, 2015 at 18:05 | #32


    Perhaps it’s just me, in which case you should ignore the point, but I think less is usually more when it comes to killer polemical points. The basic facts about your characters should be left to speak for themselves as much as possible. Instead you provide us with a full interpretation of the facts (admittedly with some caveats to follow which restrain the picture somewhat). But I think more simple facts and, given that at least some reasonable people might not agree with them, I’d prefer less spoon-feeding with definitive interpretations.

    I found the guilt by association via Orwell and Burnham had a tendentious flavour to it.

  33. Newtownian
    May 29th, 2015 at 12:21 | #33

    Another suggestion at the risk of being an ecological nag. I would like to see you include in your book a section on the ecological economics pespective (doesnt have have to be pro – just a discussion.) A possible focus could be the views of Herman Daly nicely summarised in this collection of essays.


    Most relevant to your book seems to be chapter 5 which deals with the concept of utility which is covered in this section of your forthcoming book.

    This section is quite short so I’ve reproduced it below to help you decide on whether its worth incorporating. Hopefully its short enough to be “fair dealing”. In any case I suspect you entitled to get it free from RER.

    Chapter 5
    Three limits to growth
    As production (real GDP) grows, its marginal utility declines, because we
    satisfy our most important needs first. Likewise, the marginal disutilitiy inflicted
    by growth increases, because as the economy expands into the ecosphere
    we sacrifice our least important ecological services first (to the extent we know
    them). These rising costs and declining benefits of growth at the margin are
    depicted in the diagram below.
    From the diagram we can distinguish three concepts of limits to growth.
    1. The “futility limit” occurs when marginal utility of production falls to zero.
    Even with no cost of production, there is a limit to how much we can consume
    and still enjoy it. There is a limit to how many goods we can enjoy in a given
    time period, as well as a limit to our stomachs and to the sensory capacity of
    our nervous systems. In a world with considerable poverty, and in which the
    poor observe the rich apparently still enjoying their extra wealth, this futility
    limit is thought to be far away, not only for the poor, but for everyone. By its
    “non satiety” postulate, neoclassical economics formally denies the concept of
    the futility limit. However, studies showing that beyond a threshold selfevaluated
    happiness (total utility) ceases to increase with GDP, strengthen the
    relevance of the futility limit.
    2. The “ecological catastrophe limit” is represented by a sharp increase to the
    vertical of the marginal cost curve. Some human activity, or novel combination
    of activities, may induce a chain reaction, or tipping point, and collapse our
    ecological niche. The leading candidate for the catastrophe limit at present is
    runaway climate change induced by greenhouse gasses emitted in pursuit of
    economic growth. Where along the horizontal axis it might occur is uncertain. I
    should note that the assumption of a continuously and smoothly increasing
    marginal cost (disutility) curve is quite optimistic. Given our limited
    understanding of how the ecosystem functions, we cannot be sure that we
    have correctly sequenced our growth-imposed sacrifices of ecological
    services from least to most important. In making way for growth, we may
    ignorantly sacrifice a vital ecosystem service ahead of a trivial one. Thus the
    marginal cost curve might in reality zig-zag up and down discontinuously,
    making it difficult to separate the catastrophe limit from the third and most
    important limit, namely the economic limit.
    3. The “economic limit” is defined by marginal cost equal to marginal benefit
    and the consequent maximization of net benefit. The good thing about the
    economic limit is that it would appear to be the first limit encountered. It
    certainly occurs before the futility limit, and likely before the catastrophe limit,
    although as just noted that is uncertain. At worst the catastrophe limit might
    coincide with and discontinuously determine the economic limit. Therefore it is
    very important to estimate the risks of catastrophe and include them as costs
    counted in the disutility curve, as far as possible.
    From the graph it is evident that increasing production and consumption is
    rightly called economic growth only up to the economic limit. Beyond that point
    it becomes uneconomic growth because it increases costs by more than
    benefits, making us poorer, not richer. Unfortunately it seems that we
    perversely continue to call it economic growth! Indeed, you will not find the
    term “uneconomic growth” in any textbook in macroeconomics. Any increase
    in real GDP is called “economic growth” even if it increases costs faster than
    Economists will note that the logic just employed is familiar in microeconomics
    – marginal cost equal to marginal benefit defines the optimal size of a
    microeconomic unit, be it a firm or household. That logic is not usually applied
    to the macro-economy, however, because the latter is thought to be the
    Whole rather than a Part. When a Part expands into the finite Whole, it
    imposes an opportunity cost on other Parts that must shrink to make room for
    it. When the Whole itself expands, it is thought to impose no opportunity cost
    because it displaces nothing, presumably expanding into the void. But the
    macro-economy is not the Whole. It too is a Part, a part of the larger natural
    economy, the ecosphere, and its growth does inflict opportunity costs on the
    finite Whole that must be counted. Ignoring this fact leads many economists to
    believe that growth in GDP could never be uneconomic.
    Standard economists might accept this diagram as a static picture, but argue
    that in a dynamic world technology will shift the marginal benefit curve upward
    and the marginal cost curve downward, moving their intersection (economic
    limit) ever to the right, so that continual growth remains both desirable and
    possible. However, the macroeconomic curve-shifters need to remember
    three things. First, the physically growing macro-economy is still limited by its
    displacement of the finite ecosphere, and by the entropic nature of its
    maintenance throughput. Second, the timing of new technology is uncertain.
    The expected technology may not be invented or come on line until after we
    have passed the economic limit. Do we then endure uneconomic growth while
    waiting and hoping for the curves to shift? Third, let us remember that the
    curves can also shift in the wrong directions, moving the economic limit back
    to the left. Did the technological advances of tetraethyl lead and
    chlorofluorocarbons shift the cost curve down or up? How about nuclear
    power? Adopting a steady state economy allows us to avoid being shoved
    past the economic limit. We could take our time to evaluate new technology
    rather than letting it blindly push growth that may well be uneconomic. And the
    steady state gives us some insurance against the risks of ecological
    catastrophe that increase with growthism and technological impatience.

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