Economics Pareto efficiency & Kaldor Hick Efficiency

Introduction to Law & Econ A. Pareto efficiency A Pareto improvement occurs when a change in allocation harms no one and helps at least one person, given an initial allocation of goods for a set of persons. As such, a Pareto improvement occurs when an economic action leads to a net welfare gain, without anyone being made worse off. Consider these two distributions of goods between three individuals, A, B and C. Distribution 1 Distribution 2 A 4 5 B 4 X C 1 2 1. How big does X have to be in order for Distribution 2 to be a Pareto improvement over Distribution 1? __ Now consider a different scenario. Distribution 1 Distribution 2 A 5 9 B 4 X C 2 1 2. Is there any value of X that will cause Distribution 2 to be a Pareto improvement over Distribution 1? Why? ________________________________ B. Kaldor-Hick Efficiency (“aggregate efficiency”) Using the criterion for Kaldor–Hicks, an improvement arises when the aggregate gains exceed the aggregate losses. The idea is that those that are made better off could in principle compensate those that are made worse off, so that a Pareto improving outcome could (though does not have to) be achieved. Consider again this scenario. Distribution 1 Distribution 2 A 5 9 B 4 X C 2 1 3. How big does X have to be in order for Distribution 2 to be a Kaldor-Hicks improvement over Distribution 1? ____ END OF DOCUMENT