Kaldor–Hicks efficiency

The Kaldor -Hicks criterion (after Nicholas Kaldor and John Richard Hicks ) is a welfare criterion, which is based on the idea of a potential interpersonal compensation (compensation) based on wealth changes. It thus belongs to the compensation criteria, such as also the Scitovsky criterion or the criteria by Samuelson and Gorman. Unlike the Pareto criterion, in which changes in an economic situation under affluent aspects can be assessed only if no contrary individual welfare changes occur ( lack of interpersonal utility comparison), try compensation criteria to evaluate also those overall social welfare changes, in which the welfare of individuals increases while the other decreases. Thus, the criteria set out trying to offset welfare gains and welfare losses against each other.

Representation

According to the Kaldor -Hicks criterion is always spoken of a total social welfare increases when the individuals that experienced by the change in the economic situation of an increased prosperity, can fully compensate those individuals who suffer which welfare losses and, ultimately, still retaining some of the original welfare gain.

The following picture is for illustration of the criterion:

Shown are the utility possibility curves of two individuals X and Y by the distance trains AB and CD. In the initial situation was relevant to the utility possibility curve AB, the distribution F situation. After the change of economic situation, the utility possibility curve CD and the corresponding distribution situation applies whether L. According to the Pareto criterion, the new situation with the old can not be compared in terms of the welfare aspect, because while the welfare of the individual X has dropped is that of Y increased. According to the Kaldor - Hicks criterion, the change in the distribution situation is, however, the whole of society welfare enhancing, because starting from the situation L is the real allocation of new goods bundle could be such that the point M is reached in which the welfare of the X compared to the situation in F is unchanged, while the welfare of the Y has risen. Accordingly, any changes in the real allocation would be welfare improving society as a whole, in which a point on the utility possibility curve is that of a CD, which lies within the Pareto region of F ( dashed lines).

It is important to know that the Kaldor -Hicks criterion only requires that a compensation of the utility loss of the disadvantaged economic agents is possible by shared before, not that this will actually take place. To assess the desirability of such a measure, it requires an additional value judgment.

Criticism

A short time after its conception came criticism of the Kaldor -Hicks criterion relating to its consistency. It was found that the criterion in certain situations is not reversible. Thus, it is possible to show that the change of economic situation, which is the whole of society welfare enhancing by this criterion, also leads to an increased prosperity, when you return to the initial situation. This issue may occur if the respective utility possibility curves intersect (as shown in the figure), which always happens when the bundle of goods viewed by the change in the economic situation is not preferred by both business entities the old bundle of goods. With such situations, V.A. then be expected if the preferences of the individuals under consideration differ greatly.

In order to explain the lack of consistency of the Kaldor -Hicks criterion, it will be assumed that in the initial situation, the utility possibility curve AB and the distribution situation, let F be relevant. After the change of the economic situation now was the utility possibility curve CD and the distribution situation G, in which the welfare of X has increased, while that of Y is decreased. By G from but lets through redistribution of goods bundle H, the situation reached in which remained the welfare of Y in comparison to the starting point and equal to that of X is increased. According to the Kaldor - Hicks criterion, the overall social welfare is thus increased. To return from G to F but this is also true because of F from the point N would be achieved has increased during which the welfare of the X compared to G, while that of Y remained constant. Obviously, you get in both directions to an increase in overall social welfare, which must be a contradiction. Such inconsistencies occur at intersecting utility possibility curves whenever the are of relevance according to the change of the economic situation distribution situations on different sides of the intersection of the corresponding utility possibility curves.