Summary
The 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.Compensation criteria:
- Definition
- Kaldor’s criterion
- Hicks’ criterion
- Scitovsky’s criterion
- Little’s criterion
- Samuelson’s criterion
Theory of the…
he Kaldor criterion is a compensation criterion developed by Nicholas Kaldor in his paper “Welfare Propositions of Economics and Interpersonal Comparisons of Utility”, 1939. This criterion is satisfied if state Y is preferred to state X and there is such a compensation and reassignment that Y turns to Yˈ that is at least as good as X in a Pareto sense. In the following graph we consider the utility of two individuals (A on the x-axis and B on the y-axis), which we will compare using the utility possibility frontier of two different moments.
When moving from state X to Y, individual A’s utility decreases, while individual B’s increases. Individual B is willing to compensate individual A and move to Yˈ where both increase their initial utility. The opposite, moving from Y to X, can also occur if the winner, this time individual A, compensates the looser, individual B, and is willing to relocate to Xˈ.
When moving from state Y to Z, the utility of individual A decreases, while individual B’s increases. Individual B is willing to compensate individual A and go to Zˈ where both increase their initial utility. On this case the opposite, moving from Z to Y, would not be feasible.
Tibor Scitovsky pointed out some inconsistencies and the consequent limitations of this criterion which are known as the Scitovsky paradox. This paradox is centred in the phenomenon that while Y can be preferred to X the opposite can also be true, as it was previously explained. This does not give a truly asymmetric result as it could just mean that going back to the initial situation is preferred. Economy would therefore oscillate between both points.
