Pareto Optimal Outcomes and Competitive Equilibrium:

Market economy has been the central focus for much of the analysis in economic theory. In a market economy individual consumers have ownership rights to various assets and are free to trade these assets in the market place for other assets or goods.

Likewise, firms, which are themselves owned by consumers, decide on their production plan and trade in the market to secure necessary inputs and sell the resulting outputs. Roughly speaking, we can identify a market equilibrium or a competitive equilibrium as an outcome of a market economy in which each agent in the economy (i.e., each consumer and firm) is doing her best, given the actions of all other agents.

We can now examine the question how well market economy performs in obtaining socially optimal plan of production and consumption. To understand market failure it is important to first understand 'market success'. The ability of competitive markets to achieve an equilibrium allocation of resources which is Pareto optimal is termed as markt success. The efficiency property of markets is contained in the theorems of modern welfare economics. An important concept used in stating efficiency property of markets is Pareto optimality.

Definition : A Pareto optimum is a.feasible allocation such that there exists no other.feasible allocation that would give at least as much utility to all consumers and more utility to at least one consumer' Pareto optimality is an efficiency concept that implies that the economic situation of one individual can be improved only if the economic situation of another individual is worsened.