Kaldor Hicks Compensation Criterion
The Pareto optimality criterion states that social welfare increases if a reallocation of resources
makes at least one individual better off without making any one worse off. But in reality most
of the situations economic changes make some people better off and some others worse off. In
such situations it is possible to increase the social welfare so long as the person who gains from
the change is able and willing to compensate those who lose from the change and the losers are
remain better off than before. Pareto optimality criterion does not evaluate the above discussed
situations. To overcome this limitation of the Pareto optimality criterion of maximum social
welfare, Kaldor and Hicks developed an alternative criterion which is known as compensation
criteria.
Kaldor (Welfare propositions in Economics and Interpersonal Comparison of Utility) and
Hicks (The Foundations of Welfare Economics) proposed their compensation criterions in their
separate articles published in 1939. Their criterions are conceptually very similar therefore
jointly referred to as Kaldor-Hicks Criterion. However, there is a minor difference between the
criterion suggested by Kaldor and Hicks. While Kaldor evaluates compensation from the
gainers point of view, Hicks does it from loser’s point of view.
According to Kaldor welfare criterion, if a certain economic or policy change makes some
people better off and others worse off. Then that change will increase social welfare if those
who gain from the change could compensate the losers and the gainers were still better off than
before. According to Hicks if an economic change makes some people gain and some others
loss and losers are not able to compensate the gainers to prevent them from voting for the
change, then the change is socially desirable.
Kaldor – Hicks compensation criteria can be explained with the help of the following diagram
W
U
Q
utility
J
B’ s
K R
M
P D
O
A’s Utility
In the above figure utility of consumer B is measures along the vertical axis and the utility of
consumer A is measured along the horizontal axis. UP and WD are two utility possibility curves
before and after the economic change or the reallocation of resources. The curve UP shows the
various combination of utility received by individuals A and B in the utility space when the
Dr Ratheesh C, Assistant Professor, Department of Economics, FMNC, Kollam Page 1
The Pareto optimality criterion states that social welfare increases if a reallocation of resources
makes at least one individual better off without making any one worse off. But in reality most
of the situations economic changes make some people better off and some others worse off. In
such situations it is possible to increase the social welfare so long as the person who gains from
the change is able and willing to compensate those who lose from the change and the losers are
remain better off than before. Pareto optimality criterion does not evaluate the above discussed
situations. To overcome this limitation of the Pareto optimality criterion of maximum social
welfare, Kaldor and Hicks developed an alternative criterion which is known as compensation
criteria.
Kaldor (Welfare propositions in Economics and Interpersonal Comparison of Utility) and
Hicks (The Foundations of Welfare Economics) proposed their compensation criterions in their
separate articles published in 1939. Their criterions are conceptually very similar therefore
jointly referred to as Kaldor-Hicks Criterion. However, there is a minor difference between the
criterion suggested by Kaldor and Hicks. While Kaldor evaluates compensation from the
gainers point of view, Hicks does it from loser’s point of view.
According to Kaldor welfare criterion, if a certain economic or policy change makes some
people better off and others worse off. Then that change will increase social welfare if those
who gain from the change could compensate the losers and the gainers were still better off than
before. According to Hicks if an economic change makes some people gain and some others
loss and losers are not able to compensate the gainers to prevent them from voting for the
change, then the change is socially desirable.
Kaldor – Hicks compensation criteria can be explained with the help of the following diagram
W
U
Q
utility
J
B’ s
K R
M
P D
O
A’s Utility
In the above figure utility of consumer B is measures along the vertical axis and the utility of
consumer A is measured along the horizontal axis. UP and WD are two utility possibility curves
before and after the economic change or the reallocation of resources. The curve UP shows the
various combination of utility received by individuals A and B in the utility space when the
Dr Ratheesh C, Assistant Professor, Department of Economics, FMNC, Kollam Page 1
