Allocative efficiency, the idea that society is provided the right mix of goods, comes from the theory of Pareto optimality. Named for its creator, Vilfredo Pareto (1848-1923), Pareto optimality is described as a condition where no one can be made better off without making someone else worse off. For the optimal allocation of goods and services to occur, Pareto argued that three conditions had to be met. First, there must be an optimal distribution of goods, meaning that goods are divided amongst people in a way that maximizes total satisfaction. The second condition is the optimal technical allocation of resources. Like the notion of productive efficiency, society must produce its goods and services using the least costly combination of input. Third, there must be optimal quantities of the different outputs produced. For this to occur, quantities of each good must be produced up to the point where the marginal benefit equals the marginal cost. Born in Paris to Italian parents, Pareto studied mathematics, physics, and engineering at the University of Turin in Italy. He spent time as the director of the Italian railway, but in 1893 replaced Leon Walras (1834-1910) as the chair of political economy at the University of Lausanne in Switzerland. Pareto is referred to as a welfare economist, meaning his analysis focused on maximizing society’s well-being.

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10.2 Consumer Surplus

Alfred Marshall is credited with developing the concept of consumer surplus. Although the idea originated with Jules Dupuit (1804-1866), a French economist, Marshall first used the term and refined the concept. As Marshall explained consumer surplus, "The price which a person pays for a thing can never exceed, and seldom comes up to that which he would be willing to pay rather than go without it: so that the satisfaction which he gets from its purchase generally exceeds that which he gives up in paying away its price; and he thus derives from the purchase a surplus of satisfaction. The excess of price which he would be willing to pay rather than go without the thing, over that which he actually does pay, is the economic measure of this surplus satisfaction. It may be called consumer’s surplus."(1) Alfred Marshall (1842-1924) was born in Clapham, England, the son of a cashier of the Bank of England. Despite his father’s wishes that he study for the ministry at Oxford, Marshall attended Cambridge University, where he studied mathematics, physics and economics. In 1877 he married one of his students, Mary Paley. They collaborated on his first book, The Economics of Industry, published in 1879.(2) The leading economist of his time, Marshall belonged to what economists refer to as the Neoclassical school of economic thought. Much of what appears in your textbook comes from Neoclassical economics, and Marshall’s contributions have stood the test of time. Although Marshall used mathematics extensively in his economic models, he emphasized that the math was merely a shorthand language, and not the foundation for economic inquiry and analysis. Marshall established his own set of rules for the use of mathematics in economic theorizing: "(1) Use mathematics as a shorthand language, rather than as an engine of inquiry. (2) Keep to them till you have done. (3) Translate into English. (4) Then illustrate by examples that are important in real life. (5) Burn the mathematics. (6) If you can’t succeed in (4), burn (3). This last I [Marshall] did often."(3) Ibid. 124. William Breit and Roger Ransom, The Academic Scribblers, (New York: Holt, Rinehart and Winston, Inc., 1971), 21. Alfred Marshall, Memorials of Alfred Marshall, ed. A.C. Pigou (London: Macmillan, 1925), 427