Question

Explain the following three concepts: Kaldor-Hicks criterion, Pareto efficiency, and Cost- Benefit analysis? Also explain the how these three concepts are linked together.

Answer 1

Kaldor hicks criterion

A reallocation is said to be a Pareto improvement if at least one person is made fortunate and nobody is made worse off. However in practice, it is almost impossible to take any social action, such as a change in economic policy, without making at least one person worse off. Even voluntary exchanges may not be Pareto improving if they make third parties worse off.

Using the criterion for Kaldor–Hicks improvement, an outcome is an improvement if those that are made better off could in principle compensate those that are made worse off, so that a Pareto improving outcome could be achieved.

Pareto efficiency

Pareto efficiency or Pareto optimality is a state of allocation of resources from which it is impossible to reallocate so as to make any one individual or preference criterion better off without making at least one individual or preference criterion worse off.Also resources are allocated in an efficient manner but doesn’t imply equality of fairness.

Cost benefit analysis

It’s a simple quantitative approach whether to get ahead with decision or not.cost benefit analysis (also known as a benefit cost analysis) is a process by which organizations can analyze decisions, systems or projects, or find a value for intangibles or which cannot be seen.The model is built by identifying the benefits of an action as well as the associated costs, and subtracting the costs from benefits.

Kaldor-Hicks efficiency in welfare economics is a criterion for judging reallocations of resources among individuals, resulting in gains to some but losses to others. The Pareto criterion specifies that there is an improvement in efficiency if at least one party gains while no other party loses from reallocation and efficient utilisation of resources takes place.