Question

Explain why the equilibrium price and quantity is Pareto efficient. As part of your explanation, you must explain what is Pareto efficiency and show that it fits this definition. Pareto efficiency refers to a market equilibrium that is perfectly competitive. A market is considered Pareto efficient where any change to the price from its equilibrium level would cause in a reduction of the total surplus (area shaded in blue). Thus, any reduction in the total surplus would cause a change in the consumer and producer surpluses rendering either the consumer or producer better off at the expense of the other becoming worse off. The market for microphones is Pareto efficient because any attempt to move the price from its equilibrium level (P*=$5.33) would result in a reduction of the total surplus for buyers and sellers of microphones.

For example, if we increased the price for microphones, the quantity demanded would reduce and the total surplus would decrease. Likewise, if we reduced the price for microphones, the quantity supplied would fall and the total surplus would decrease. Therefore, in the absence of a Pareto improving transaction, it can be concluded that the market for microphones is Pareto efficient at the equilibrium price of $5.33.

Answer 1

Pareto efficiency is term used to describe when allocation of resources makes one individual better off without making other individual to worse off and thus impossible to reallocate ahead.

An equilibrium price or quantity is pareto efficient because at this point we dont observe producer surplus or consuner surplus and hence both producer and consuner are in win win situation or in other terms mutually satisfied without making either if them better off or worse off.

Now, If the price is increased then quantity will decrease and hence will make the producer well off. If the price is decreased then quantity will increase making the consumer well off. Thus this change will not results in Pareto optimal condition And hence the equilibrium point is termed as Pareto Optimal or Pareto efficient.