Efficiency Criteria: Pareto-Optimality

Part A – Pareto Efficiency (Q1–Q12)

1. A situation is Pareto optimal when:

(A) Everyone is equally well-off
(B) No one can be made better off without making someone worse off ✅
(C) Total utility is maximized
(D) Social welfare is at its peak

Explanation:
Pareto optimality means all mutual gains are exhausted — improving one person’s welfare necessarily harms another.

2. A Pareto improvement refers to:

(A) Everyone benefits equally
(B) At least one person gains and no one loses ✅
(C) Some gain and others lose
(D) Redistribution of income

Explanation:
A Pareto improvement makes at least one person better off while leaving others no worse off.

3. Pareto efficiency ensures:

(A) Fair income distribution
(B) Maximized total wealth
(C) Economic efficiency ✅
(D) Social justice

Explanation:
It is a test of efficiency, not equity — it says nothing about fairness or income equality.

4. Which economist first introduced the Pareto criterion?

(A) Alfred Marshall
(B) Vilfredo Pareto ✅
(C) A.C. Pigou
(D) Nicholas Kaldor

Explanation:
Italian economist Vilfredo Pareto (1906) developed the efficiency concept now called Pareto optimality.

5. Pareto optimality occurs when:

(A) $M R S_{A} = M R S_{B}$ ✅
(B) $M R T S_{A} = M R T S_{B}$
(C) $M R S \neq M R T$
(D) Marginal utilities are zero

Explanation:
In exchange efficiency, the marginal rates of substitution (MRS) between goods are equal for all individuals.

6. Efficiency in production under Pareto optimality requires:

(A) $M R T S_{L K}^{X} = M R T S_{L K}^{Y}$ ✅
(B) $M R S_{A} = M R S_{B}$
(C) $M R S = M R T$
(D) $M U_{X} = M U_{Y}$

Explanation:
Production efficiency demands equal MRTS (Marginal Rate of Technical Substitution) for all firms using the same factors.

7. Efficiency in product-mix requires:

(A) $M R S = M R T$ ✅
(B) $M R S_{A} = M R S_{B}$
(C) $M R T S_{X} = M R T S_{Y}$
(D) $M R S = M U$

Explanation:
For optimal product mix, the rate at which consumers are willing to substitute (MRS) equals the rate at which producers can transform goods (MRT).

8. Pareto Optimality implies:

(A) Equal income distribution
(B) Absence of waste ✅
(C) Maximum happiness
(D) Minimum cost

Explanation:
Pareto efficiency implies that no reallocation can increase someone’s welfare without reducing someone else’s — resources are fully utilized.

9. A limitation of Pareto Optimality is that:

(A) It allows interpersonal comparison of utilities
(B) It ignores distributional issues ✅
(C) It cannot show efficiency
(D) It depends on money income only

Explanation:
Pareto criterion is silent on how income or welfare is distributed — inequality can persist in a Pareto-efficient state.

10. In welfare economics, Pareto optimality is achieved when:

(A) Social welfare function is constant
(B) Exchange, production, and product-mix efficiencies exist ✅
(C) Government redistributes income
(D) Market prices are fixed

Explanation:
The three types of efficiency — exchange, production, and product mix — together define Pareto optimality.

11. Pareto criterion avoids:

(A) Value judgment
(B) Utility measurement
(C) Interpersonal comparison of utility ✅
(D) Price analysis

Explanation:
Pareto avoided comparing utilities across persons; his criterion is based on ordinal (non-comparable) preferences.

12. The Edgeworth box helps to explain:

(A) Business cycles
(B) Pareto efficiency in exchange ✅
(C) Monopoly power
(D) Externalities

Explanation:
The Edgeworth box graphically represents efficient allocations (Pareto optimal points) where indifference curves are tangent.

Part B – Kaldor–Hicks Compensation Criterion (Q13–Q22)

13. The Kaldor–Hicks criterion allows welfare improvement when:

(A) All individuals gain
(B) Gainers could compensate losers and still be better off ✅
(C) Actual compensation occurs
(D) Total income is redistributed

Explanation:
The test looks for potential compensation — gainers could compensate losers even if no payment is made.

14. The Kaldor–Hicks test is also known as:

(A) Actual compensation principle
(B) Potential compensation principle ✅
(C) Equity test
(D) Utility test

Explanation:
It measures potential welfare improvement, not actual transfers — hence, “potential compensation principle.”

15. The Kaldor–Hicks criterion is useful because:

(A) It includes ethical judgments
(B) It can evaluate policies that help some and harm others ✅
(C) It ensures equality
(D) It always benefits the poor

Explanation:
Unlike Pareto, it allows for trade-offs between winners and losers, making it practical for real-world policy evaluation.

16. Kaldor’s version emphasizes:

(A) Losers can bribe gainers
(B) Gainers can compensate losers ✅
(C) Everyone must gain
(D) Welfare remains constant

Explanation:
Kaldor stated that a change is desirable if gainers could compensate losers and still remain better off.

17. Hicks’s version of the criterion states that:

(A) Losers can bribe gainers not to change ✅
(B) Gainers always pay losers
(C) Equal compensation occurs
(D) Total income is constant

Explanation:
Hicks formulated the same idea oppositely — a change is desirable if losers cannot bribe gainers enough to prevent it.

18. The Kaldor–Hicks criterion is based on:

(A) Utility comparison
(B) Monetary evaluation of gains and losses ✅
(C) Equal utility
(D) Happiness index

Explanation:
It uses money value as a measure of welfare change, not direct utility.

19. The Kaldor–Hicks test resolves the main weakness of:

(A) Pareto criterion ✅
(B) Pigovian welfare theory
(C) Wealth maximization
(D) Utilitarianism

Explanation:
It overcomes Pareto’s limitation by allowing welfare analysis when some gain and others lose.

20. Which paradox questions the consistency of Kaldor–Hicks test?

(A) Edgeworth paradox
(B) Scitovsky paradox ✅
(C) Giffen paradox
(D) Bertrand paradox

Explanation:
Scitovsky showed that a move from A→B and then B→A can both satisfy the compensation test — hence inconsistency.

21. The compensation principle is most useful in:

(A) Monopoly theory
(B) Cost–benefit analysis ✅
(C) Labour economics
(D) Game theory

Explanation:
It provides a theoretical basis for cost–benefit analysis, where gains and losses are measured in monetary terms.

22. A criticism of Kaldor–Hicks is that:

(A) It’s too restrictive
(B) It ignores possibility of actual compensation ✅
(C) It always favors the poor
(D) It cannot be measured

Explanation:
The criterion tests for potential compensation, but in reality, losers are often not compensated.

Part C – Wealth Maximization (Q23–Q30)

23. The Wealth Maximization criterion was popularized by:

(A) Alfred Marshall
(B) Richard Posner ✅
(C) Nicholas Kaldor
(D) J.R. Hicks

Explanation:
Judge Richard A. Posner (Chicago School) promoted the idea that legal and economic efficiency is achieved through wealth maximization.

24. According to wealth maximization, efficiency is achieved when:

(A) Everyone’s utility is equal
(B) Total monetary value of resources is maximized ✅
(C) Income is equally distributed
(D) Market power is minimized

Explanation:
This approach focuses on maximizing total wealth, measured in monetary terms, not on individual satisfaction.

25. Wealth maximization is considered a:

(A) Moral criterion
(B) Monetary criterion ✅
(C) Utility-based test
(D) Egalitarian approach

Explanation:
It evaluates welfare in terms of monetary value of goods and resources rather than personal utility.

26. The Wealth Maximization criterion assumes:

(A) Market prices reflect individuals’ valuations ✅
(B) Utility is measurable
(C) Equality of income
(D) Perfect altruism

Explanation:
It is assumed that prices in competitive markets correctly measure how much people value goods and services.

27. The Wealth Maximization criterion is closely related to:

(A) Pareto criterion
(B) Kaldor–Hicks criterion ✅
(C) Marxian welfare theory
(D) Rawlsian justice theory

Explanation:
Wealth maximization is a monetized version of Kaldor–Hicks — focusing directly on aggregate market value.

28. In corporate economics, wealth maximization implies:

(A) Maximizing total sales
(B) Maximizing shareholders’ value ✅
(C) Equal distribution of profits
(D) Minimizing social costs

Explanation:
In business decision-making, the objective of wealth maximization means increasing the firm’s market value for shareholders.

29. A key limitation of wealth maximization is that it:

(A) Ignores distribution and equity ✅
(B) Lacks objectivity
(C) Cannot be quantified
(D) Requires welfare comparison

Explanation:
Since wealth maximization values outcomes by willingness to pay, it favors the rich, ignoring social fairness.

30. Wealth Maximization differs from Pareto optimality because it:

(A) Considers only efficiency
(B) Allows losers if total wealth rises ✅
(C) Requires all to gain
(D) Ignores money valuation

Explanation:
Pareto efficiency forbids making anyone worse off; wealth maximization permits some losses if aggregate wealth increases.

Tag: Efficiency Criteria: Pareto-Optimality

UGC NET Economics Unit 1-Efficiency Criteria: Pareto-Optimality, Kaldor–Hicks & Wealth Maximization/MCQs