Compensation principle
Encyclopedia
In welfare economics
, the compensation principle refers to a decision rule used to select between pairs of alternative feasible social states. One of these states is the hypothetical point of departure ("the original state"). According to the compensation principle, if the prospective gainers could compensate (any) prospective losers and leave no one worse off, the other state is to be selected (Chipman, 1987, p. 524). An example of a compensation principle is the Pareto criterion
in which a change in states entails that such compensation is not merely feasible but required. Two variants are:
In non-hypothetical contexts such that the compensation occurs (say in the marketplace), invoking the compensation principle is unnecessary to effect the change. But its use is more controversial and complex with some losers (where full compensation is feasible but not made) and in selecting among more than two feasible social states. In its specifics, it is also more controversial where the range of the decision rule itself is at issue.
Uses for the compensation principle include:
Welfare economics
Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...
, the compensation principle refers to a decision rule used to select between pairs of alternative feasible social states. One of these states is the hypothetical point of departure ("the original state"). According to the compensation principle, if the prospective gainers could compensate (any) prospective losers and leave no one worse off, the other state is to be selected (Chipman, 1987, p. 524). An example of a compensation principle is the Pareto criterion
Pareto efficiency
Pareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
in which a change in states entails that such compensation is not merely feasible but required. Two variants are:
- the Pareto principle, which requires any change such that all gain.
- the (strong) Pareto criterion, which requires any change such that at least one gains and no one loses from the change.
In non-hypothetical contexts such that the compensation occurs (say in the marketplace), invoking the compensation principle is unnecessary to effect the change. But its use is more controversial and complex with some losers (where full compensation is feasible but not made) and in selecting among more than two feasible social states. In its specifics, it is also more controversial where the range of the decision rule itself is at issue.
Uses for the compensation principle include:
- comparisons between the welfare properties of perfect competitionPerfect competitionIn economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...
and imperfect competitionImperfect competitionIn economic theory, imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied... - the Pareto principle in social choice theory
- cost-benefit analysisCost-benefit analysisCost–benefit analysis , sometimes called benefit–cost analysis , is a systematic process for calculating and comparing benefits and costs of a project for two purposes: to determine if it is a sound investment , to see how it compares with alternate projects...
.
See also
- Compensating variationCompensating variationIn economics, compensating variation is a measure of utility change introduced by John Hicks . 'Compensating variation' refers to the amount of additional money an agent would need to reach its initial utility after a change in prices, or a change in product quality, or the introduction of new...
- Cost-benefit analysisCost-benefit analysisCost–benefit analysis , sometimes called benefit–cost analysis , is a systematic process for calculating and comparing benefits and costs of a project for two purposes: to determine if it is a sound investment , to see how it compares with alternate projects...
- Kaldor-Hicks efficiencyKaldor-Hicks efficiencyKaldor–Hicks efficiency, named for Nicholas Kaldor and John Hicks, also known as Kaldor–Hicks criterion, is a measure of economic efficiency that captures some of the intuitive appeal of Pareto efficiency, but has less stringent criteria and is hence applicable to more circumstances...
- Pareto efficiencyPareto efficiencyPareto efficiency, or Pareto optimality, is a concept in economics with applications in engineering and social sciences. The term is named after Vilfredo Pareto, an Italian economist who used the concept in his studies of economic efficiency and income distribution.Given an initial allocation of...
- Social choice theorySocial choice theorySocial choice theory is a theoretical framework for measuring individual interests, values, or welfares as an aggregate towards collective decision. A non-theoretical example of a collective decision is passing a set of laws under a constitution. Social choice theory dates from Condorcet's...
- Welfare economicsWelfare economicsWelfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...