Question

Explain the difference between the Pareto criterion and the compensation principle as rules for deciding whether a particular policy change is in the public interest.

Answer 1

Pareto criterion is based on the principle that if atleast one person is made better off without making others worse off then welfare shall increase. It rejects cardinal measure in utility that one individual can only be better off when the other is made worse off. It was criticized on the grounds that this theory is true only for cases when no one is harmed and it cannot be applied to policies where some groups are benefited over others and it measures unambiguous change in welfare.

In contrast, compensation principle introduced by Hicks, Kaldor and Scitovsky states that when an increase in welfare makes some people better off and some worse off is optimal if the gainer compensate the losers for their loss due to policy change.

Both are criticised on various grounds as not sufficient to decide whether a particular policy is in public interest but the latter would have been effective if there was actual payment of compensations. The former atleast holds true for positive premises.