Consider the following:
(i) When does the potential Pareto criterion reject a policy option?
(ii) Explain why any policy that creates a deadweight loss will be rejected by the potential Pareto criterion.
(iii) Would the competitive market outcome be rejected by the potential Pareto criterion? Why or why not?
(i) A policy option is rejected by the potential Pareto criterion whenever there exists any other option that could unanimously defeat it.
(ii) If a deadweight loss exists, then social gain is not as large as possible. In this case, further gains from trade can be created, which can then be split among the relevant parties, making everyone better off. Such a plan would receive unanimous support over the status quo. Thus a situation with a deadweight loss will be rejected by the potential Pareto criterion.
(iii) The Invisible Hand Theorem shows that competitive markets create the maximum possible social gain. If everyone values additional goods, no reallocation of goods could receive unanimous support. The competitive market outcome cannot be unanimously defeated, so it cannot be rejected by the potential Pareto criterion.
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