Kaldor-Hicks efficiency

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In economic theory, an alteration in the allocation of resources is said to be Kaldor-Hicks efficient when it produces more benefits than costs. A Pareto efficiency arises when at least one person is made better off and no one is made worse off. In practice, however, it is extremely difficult to make any change without making at least one person worse off. Under the Kaldor-Hicks efficiency test, an outcome is efficient if those who are made better off could in theory compensate those who are made worse off and so produce a Pareto efficient outcome. Although all Kaldor-Hicks efficient situations are Pareto optimal, in that no further Pareto improvements can be made, the reverse is not true. Conversely, although every Pareto improvement is a Kaldor-Hicks improvement, most Kaldor-Hicks improvements are not Pareto improvements.

Subjects: Financial Institutions and Services — Law.

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