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In welfare economics
Welfare economics

Welfare economics is a branch of economics that uses microeconomics techniques to simultaneously determine allocative efficiency within an economy and the 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.






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In welfare economics
Welfare economics

Welfare economics is a branch of economics that uses microeconomics techniques to simultaneously determine allocative efficiency within an economy and the 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 an important concept in economics with broad applications in game theory, engineering and the social sciences....
 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 competition
    Perfect competition

    In neoclassical economics and microeconomics, perfect competition describes a market in which there are many small firms, all producing homogeneous goods....
     and imperfect competition
    Imperfect competition

    In 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
    Social Choice and Individual Values

    Kenneth Arrow's monograph Social Choice and Individual Values and a theorem within it created modern social choice theory, a rigorous melding of social ethics and voting theory with an economics flavor....
  • cost-benefit analysis
    Cost-benefit analysis

    Cost-benefit analysis is a term that refers both to:* a formal discipline used to help appraise, or assess, the case for a project or proposal, which itself is a process known as project appraisal; and...
    .


See also

  • Compensating variation
    Compensating variation

    In 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 products....
  • Cost-benefit analysis
    Cost-benefit analysis

    Cost-benefit analysis is a term that refers both to:* a formal discipline used to help appraise, or assess, the case for a project or proposal, which itself is a process known as project appraisal; and...
  • Kaldor-Hicks efficiency
    Kaldor-Hicks efficiency

    Kaldor-Hicks efficiency 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 efficiency
    Pareto efficiency

    Pareto efficiency, or Pareto optimality, is an important concept in economics with broad applications in game theory, engineering and the social sciences....
  • Social choice theory
    Social choice theory

    Social choice theory studies how measures of individual interests, values, or welfares in theory could be aggregated to reach a collective decision....
  • Welfare economics
    Welfare economics

    Welfare economics is a branch of economics that uses microeconomics techniques to simultaneously determine allocative efficiency within an economy and the income Distribution associated with it....