New Horizons in Law and Economics series
Chapter 3: The Nature of Economic Efficiency
3. The nature of economic efﬁciency 3.1 INTRODUCTION Chapter 2 outlined the axioms for KHZ efﬁciency. In a formal sense some of these are redundant. Here I pare down the axioms of Chapter 2 into the three essential axioms required to generate the results in the following chapters. I deﬁne an action or decision as efﬁcient if (1) there is a positive sum for the willingness to pay (WTP) for gains and the willingness to accept (WTA) payment for losses; (2) gains and losses are measured from psychological reference points (Kahneman and Tversky 1979); (3) the transaction costs of operating in states of the world are included in costs for purposes of determining efﬁciency, but the transactions costs of changing to a new state of the world are not included. (To require economists to include the costs of persuasion in their pronouncements of what is efﬁcient would be stupefying at best.) I call an approach based on these axioms KHZ. KHZ efﬁciency has the following characteristics: (1) it is not subject to preference reversals (Zerbe 2001); (2) it satisﬁes a compensation criterion (Zerbe 2001); (3) it deﬁnes all goods for which there is a WTP as economic goods (Zerbe 1998b); (4) it includes the income distribution, as well as the fact of compensation or its lack, as an economic good, so that a project that provides compensation may be valued differently in efﬁciency from one that does not (Zerbe 1998)...
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