Law and Economics-Charles W. Upton

Hicks-Kaldor Optimality

Hicks Kaldor Optimality

Optimality

• Pareto Optimality. A change is good if– At least one party is made better off– No party is made worse off.

Hicks Kaldor Optimality

Hicks-Kaldor Optimality

Hicks Kaldor Optimality

Optimality

• Pareto Optimality. A change is good if– At least one party is made better off– No party is made worse off.

• Hicks Kaldor Optimality. A change is good if– The gains to the winners exceed the losses to

the losers.

Hicks Kaldor Optimality

Optimality

• Pareto Optimality. A change is good if– At least one party is made better off– No party is made worse off.

• Hicks Kaldor Optimality. A change is good if– The gains to the winners exceed the losses to

the losers.

The winners could compensate the losers and

make this a Pareto Optimum Change

Hicks Kaldor Optimality

An Example

• John works for Sam for 40 hours. – He loses leisure worth $200 – He grows crops which Sam sells for 300.

Hicks Kaldor Optimality

An Example

• John works for Sam for 40 hours. – He loses leisure worth $200 – He grows crops which Sam sells for $300.– If John gets paid $200-$300, it is Pareto

Optimal for him to work for Sam.

Hicks Kaldor Optimality

An Example

• John works for Sam for 40 hours.

• Suppose John doesn't get paid.

Hicks Kaldor Optimality

An Example

• John works for Sam for 40 hours.

• Suppose John doesn't get paid. – That is not Pareto Optimal.

Hicks Kaldor Optimality

An Example

• John works for Sam for 40 hours.

• Suppose John doesn't get paid. – That is not Pareto Optimal. – It is Hicks Kaldor Optimal. A payment of

$200-$300 would have left both better off.

Hicks Kaldor Optimality

Lake Restful

• The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5.

Hicks Kaldor Optimality

Lake Restful

• The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5.

• Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each.

Hicks Kaldor Optimality

Lake Restful

• The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5.

• Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each.

The non-smokers get $10 of benefits, and the Smokers get

$10 of net costs

Hicks Kaldor Optimality

Lake Restful

• The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5.

• Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each.

The non-smokers get $10 of benefits, and the Smokers get

$10 of net costs

Not Pareto Optimal

Hicks Kaldor Optimality

Lake Restful

• The town of Lake Restful decides to make some lake improvements, which are worth $10 per resident. The cost per resident is only $5.

• Lake Restful levies a cigarette tax. Since only 1/4 of the residents smoke, the smokers end up paying $20 each.

The non-smokers get $10 of benefits, and the Smokers get

$10 of net costs

Not Pareto Optimal

Hicks-Kaldor Optimal

Hicks Kaldor Optimality

Acme Paper Mill

• Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water.

Hicks Kaldor Optimality

Acme Paper Mill

• Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water.

• It would cost $200 to clean up the mess.

Hicks Kaldor Optimality

Acme Paper Mill

• Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water.

• It would cost $200 to clean up the mess.

• Acme is allowed to begin operations without paying compensation to the residents.

Hicks Kaldor Optimality

Acme Paper Mill

• Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water.

• It would cost $200 to clean up the mess.

• Acme is allowed to begin operations without paying compensation to the residents.

Not Pareto Optimal

Hicks Kaldor Optimality

Acme Paper Mill

• Acme Paper Mill, located along Lake Restful, is allowed to operate and discharge $100 of pollutants into the water.

• It would cost $200 to clean up the mess.

• Acme is allowed to begin operations without paying compensation to the residents.

Not Pareto Optimal

Hicks-Kaldor Optimal

Hicks Kaldor Optimality

The Stop Sign

• Cars go through the intersection at Third and Main without any stop sign

Hicks Kaldor Optimality

The Stop Sign

• Cars go through the intersection at Third and Main without any stop sign

• There are accidents. The town installs a stop sign.

Hicks Kaldor Optimality

The Stop Sign

• Cars go through the intersection at Third and Main without any stop sign

• There are accidents. The town installs a stop sign.

• While most benefit, the few coming from Third are inconvenienced, and on balance are net losers.

Hicks Kaldor Optimality

The Stop Sign

• Cars go through the intersection at Third and Main without any stop sign

• There are accidents. The town installs a stop sign.

• While most benefit, the few coming from Third are inconvenienced, and on balance are net losers.

Not Pareto Optimal

Hicks Kaldor Optimality

The Stop Sign

• Cars go through the intersection at Third and Main without any stop sign

• There are accidents. The town installs a stop sign.

• While most benefit, the few coming from Third are inconvenienced, and on balance are net losers.

Not Pareto Optimal

Hicks-Kaldor Optimal

Hicks Kaldor Optimality

The Defense

• This is the test used.

Hicks Kaldor Optimality

The Defense

• This is the test used.

• The transactions cost of ensuring that every stop sign installed is Pareto Optimum is enormous.

Hicks Kaldor Optimality

The Defense

• This is the test used.

• The transactions cost of ensuring that every stop sign installed is Pareto Optimum is enormous.

• While we lose from particular stop signs, we are almost certainly net beneficiaries of stop signs.

Hicks Kaldor Optimality

Three Options

• Installing stop signs without paying compensation.

• Installing stop signs and paying compensation (and bearing the transactions costs).

• Not installing stop signs at all

Hicks Kaldor Optimality

Three Options

• Installing stop signs without paying compensation.

• Installing stop signs and paying compensation (and bearing the transactions costs).

• Not installing stop signs at all

Option One is Probably Better for us than Two or

Three

Hicks Kaldor Optimality

End

©2004 Charles W. Upton