SummaryThe analysis of welfare economics is built around the concept of Pareto efficiency. However, this efficiency criterion does not always represent a satisfactory answer. In order to solve this problem, and to find a new way to establish which allocation is best, economists have been since searching for new criteria to make a more informed decision. In this Learning Path we learn about some of these criteria.
In welfare economics, compensation criteria or the compensation principle is known as a rule of decision for selecting between two alternative states. Two states will be compared; if one state provides an improvement for one part but causes deterioration in the state of the other, it will be chosen if the winner can compensate the loser’ losses until they situation is at least as good as in the initial situation. However, this compensation may not necessarily occur.
This neo-Paretian concept was developed in order to solve the dead end in which the Pareto criterion was at the moment due to its limitations. Although, in essence, the compensation principle reduces to the Pareto criterion, it values positively a wider set that allows a positive ordering without transgressing the Pareto optimal.
To this day there has not been yet a unique and definitive compensation criterion due to its limits and some of its paradoxical implication; on the contrary, a great number of similar criterions have been formulated. From them we must highlight: