In
welfare economics
Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society.
The principles of welfare economics are often used to inform public economics, which focuses on the ...
, 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 alternate state is to be selected. An example of a compensation principle is the
Pareto criterion 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
In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...
and
imperfect competition
In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition causes market inefficiencies, resulting in ...
* the Pareto principle in
social choice theory
Social choice theory is a branch of welfare economics that extends the Decision theory, theory of rational choice to collective decision-making. Social choice studies the behavior of different mathematical procedures (social welfare function, soc ...
*
cost–benefit analysis
Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives. It is used to determine options which provide the best approach to achieving benefits ...
.
See also
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References
Literature
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* {{cite journal, author1=Dehez, P., author2=Tellone, D., year=2013, url=http://sites.uclouvain.be/econ/DP/IRES/2008-10.pdf, title=Data games: Sharing public goods with exclusion, journal=Journal of Public Economic Theory, volume=15, issue=4, pages=654-673
Welfare economics