What are the Conditions of Pareto Optimality?

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Countries with different economic classes have many who suffer while others gain in wealth.
Countries with different economic classes have many who suffer while others gain in wealth. (Image: Spencer Platt/Getty Images News/Getty Images)

Pareto Optimality is a theoretical concept named after economist Vilfredo Pareto. Pareto said that 80 percent of wealth goes to 20 percent of the people, and that this condition forces a community or group to sacrifice the benefit of one of its members to continue to improve, assuming all else is equal. Certain conditions apply for this situation to occur.

Definition

Pareto Optimality assumes that resources and production have been arbitrarily distributed in such a way that someone in the population must suffer for others to improve their situation. In a dog-eat-dog seesaw sense, the concept states in essence that those who improve their circumstances do so at the expense of their neighbor, businesswise.

Tight Competition

The first condition that must be present for Pareto Optimality to occur is intense competition among industry players. There needs to be enough of a population in the affected universe that all potential room for unchallenged growth has been eliminated. New markets with few players do not qualify. Very competitive markets where market share is won from and lost to other players is more synonymous with the theory.

Limited Resources

Second, the materials and resources necessary for production to occur must be very limited. This forces market players to compete for ownership of the lifeblood that keeps their production processes going. For example, in solar panel construction, the raw material of polysilicon is integral to fabrication. Competitors must win long-term supply agreements to lock up a reliable supply or someone else will.

Commodity Products

A final condition necessary for the Optimality theory requires that the product or service sold is more of a commodity than a unique item. By being a commodity, all of the market players are essentially selling the same thing without much difference. In this respect the consumer simply buys from whoever includes benefits that are the most attractive (i.e. pricing, quality of production, marketing). This scenario creates the perfect storm for demand of supply materials and a homogeneous product market.

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