Suppose that an economy consists of only two individuals. Which of the following statements best describes the concept of Pareto efficiency in this context?

• A. An allocation is Pareto efficient if both individuals receive equal amounts of all goods.
• B. An allocation is Pareto efficient if total production is maximized, regardless of distribution.
• C. An allocation is Pareto efficient if one individual receives all goods and the other receives none.
• D. An allocation is Pareto efficient if no reallocation can make one individual better off without making the other worse off.

Answer: (D)

Verified step by step guidance

1. Understand the concept of Pareto efficiency: An allocation is Pareto efficient if there is no way to reallocate resources to make at least one individual better off without making someone else worse off.
2. Recognize that Pareto efficiency does not require equal distribution of goods between individuals; it focuses on the impossibility of improving one person's situation without harming another's.
3. Note that maximizing total production alone does not guarantee Pareto efficiency because the distribution of goods might still allow for improvements in individual welfare.
4. Understand that an allocation where one individual receives all goods and the other none is not necessarily Pareto efficient if it is possible to reallocate goods to improve the welfare of the individual with none without hurting the other.
5. Conclude that the best description of Pareto efficiency in this two-individual economy is that no reallocation can make one individual better off without making the other worse off.