compensation principle

Compensation principle has its roots in the work of French engineer and economist Jules Dupuit (1804-1866), English political economist Alfred Marshall (1842-1924) and Italian sociologist and economist Vilfredo Pareto (1848-1923).

It refers to a transfer mechanism by which total economic welfare is maximized when individuals who gain from a change in the economy compensate those who have suffered because of the change.

Compensation principle was subsequently developed into an important feature of welfare economics through the work of Hungarian-born economist Nicholas Kaldor (1908-1986) and English economist John Hicks (1904-1989). Since it does not rely on the physical transfer of money, critics maintain that the compensation principle lacks a quantifiable verification of the relative gains and losses.

Also see: cost benefit analysis, pareto optimality, scitovsky paradox, social welfare function

Source:
V Pareto, 'II massimo di utilita dato dalla libera concorrenza', Giornale degli Economisti Series, 2, 9 (July, 1894), 48-66

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