Kaldor and Hicks developed the compensation principle to evaluate changes in social welfare resulting from economic changes that help some and harm others. Their principle states that if those who gain can compensate the losers and still be better off, the change increases social welfare. They used utility possibility curves to illustrate this, showing how compensation could move individuals to a higher indifference curve. Their theory was criticized for requiring interpersonal utility comparisons and assuming compensation actually occurs.

1. KALDAR-HICKS COMPENSATION
PRINCIPLE
Economists like Kaldor and Hicks have made efforts to
evaluate the changes in social welfare resulting from
any economic reorganization which harms some
body and benefits others. These economist have
sought to remove indeterminancy in the analysis of
Pareto Optimality. They have put forward a criterion
known as compensation principle.
Assumption of the model:
1.The satisfaction of individual is independent of
others.
2. Utility can be measured ordinally and interpersonal
comparisons of utilities are not possible.

2. 3. The problem of production and exchange can be
separated from the problem of distribution.
Kaldar-Hicks was the first economists to give a
criterion based on compensating payments.
According to Kaldor , If a certain changes in
economic organization or policy makes some people
better off and others worse off, then that change will
increase social welfare if those who gain from the
change could compensate the losers and still be
better than before.
Kaldor-Hicks criterion can be explained with the help of
utility possibility curve. In the following diagram the
ordinal utility of two individuals A and B shown on x
and y axis respectively.

3. o
x
D
E
T
Q
R
S
G
B
A
Utility possibility curve

4. In the above diagram for instance the utilities obtained
by A and B from the distribution of income are
represented by Q. As a result of some change in
economic policy, the two individuals move from point Q
to T on the utility possibility curve DE, as result of this
movement from point Q to T cannot be evaluated by
the Pareto criterion.
We have to see whether the individual B who gains
with the movement from point Q to T could compensate
the individual A who is loser and still be better off than
before.
In the above figure the possibility curve DE passes
through points R,S and G. This means that by mere
distribution of income between the two individuals, that
is if individual B some compensation to individual A for
the loss suffered, they can move from position T to at
position R. It is evident from the figure that at position
R individual A is as well off as at the position Q.

5. But individual B is still better off as compared to the
position Q therefore, social welfare increases with the
movement from point Q to R.
Criticisms:
1.This theory involves interpersonal comparison the
welfare economists wanted to avoid.
2. This works only if compensation is actually paid by
the gainers.
3. This theory isolated the production and exchange
from distribution and this ignores distribution.

6. SOCIAL WELFARE FUNCTION
The concept of social welfare function was first
introduced by Prof. Bergson and later on developed
by Samulson, Tinter and Arrow. They are of the view
that no meaningful propositions can be made in
welfare economics without introducing value
judgments. The concept of social welfare is an
attempt at providing a scientifically normative study
of welfare economics.
A social welfare function shows the factors on which the
welfare of the community or of the quantities of
products consumed and services rendered each. In
its original form the Bergeson social welfare function
is formulated in a completely general manner. It is a
function which establishes a relationship between

7. And all possible variables which effect each individual’s
welfare such as a services and consumption of each
individual. It can be regarded as a function of ech
individual’s welfare. Which in turn depend on both
the distributing of welfare among all members of the
community. Thus the social welfare function is an
ordinal index of the society’s welfare and is a function
of individual utilities. It is expressed as “
W=F(U1,U2,U3,……Un)
Where W is the social economic welfare, F is the
function and U1,U2..Un are the levels of utilities
1.2,3, n individuals, W is the increasing function of
these utilities.

8. 1.Kaldor_ Hiscks Criterion were
a) similar b) different
c) fairly similar d) non of these.
2.Compensation criterion was suggested by
a. Kaldor b. Hicks
c. Both d. Walras
3. Who wan the noble prize for contribution to welfare
economics
a. Arrow b. J.K. Galbraith
c. A.K. sen d. Non of these
4.Efficiency distribution points
a. MRSxy of A=MRSxy of B
b. MRSxy of A > MRSxy of B
c. MRSxy of A < MRSxy of B
d. Non of these.
5.Pareto optimality can take place at any point on
a. Laffer curve b. Engel curve
c. lorenz curve d. contact curve

9. 6.Pareto optimality is located
a. Marshall box b. Pareto box
c. Edgeworth box d. Non of these
7.Equality in the MRTS between labour and capital
leads to optimization in:
a. consumption b. production
c. Composition d. non of these