Question

“Compensation is part of the definition of Pareto-efficiency but whether compensation is actually paid is a question of social justice”. Elaborate on this statement.

Answer 1

Pareto laid the foundation of the modern welfare economics by formulating the concept of social optimum which is based on the concept of ordinal utility and is free from interpersonal comparisons of utilities and value judgments. Pareto states simply that an economic change which harms no one and makes someone better off indicates an increase in social welfare. According to the Pareto-efficiency principle states that an allocation of resources in the economy is economically efficient if it is impossible to reallocate the resources so as to make at least one person feel better off without making someone else feel worse off. When implementing a policy is Pareto efficient means that net social surplus increase, implies that the gains to the winners outweigh the losses to the losers. Therefore, it would be possible in principle for the winners to compensate the losers while still gaining from the policy. There is controversy over the concept of Pareto efficiency regarding the distribution of output among individual members of society. The controversy mainly shows in case of basic commodities, such as health care, education and justice. Commodities that most modern societies do not wish to distribute strictly on the basis of price and ability to pay. However, society might decide that, even though there are losers, they shall not be given compensation. This might be due to the fact that compensation is very costly or even unfeasible. Sometimes it is not possible to identify all the winners and losers. In deciding whether or not to assign compensation, society is taking a stand on the debate between efficiency and social justice. Compensation is no longer required to achieve efficiency since this follows directly from is exclusively a matter of social justice.