Compensation Principle

The compensation principle (often referred to as the compensation criterion) is a consequentialist normative criterion (actually a pair of criteria) independently proposed by Nicholas Kaldor and John Hicks. The principle is used in a range of applied economic settings, including public economics, cost-benefit analysis of government projects, law and economics, and international trade policy. The principle is most useful when analyzing policy changes that are likely to result in some people becoming better off (“winners”) and some people becoming worse off (“losers”). Such situations are, of course, the rule rather than the exception when it comes to implementing economic policy reform or indeed any policy change.

The two versions of the principle are as follows:

• 1.
  The Kaldor compensation principle assumes that a policy change has been implemented ...