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Economic Efficiency in Law and Economics

Richard O. Zerbe Jr.

In this path-breaking book, Richard Zerbe introduces a new way to think about the concept of economic efficiency that is both consistent with its historical derivation and more useful than concepts currently used. He establishes an expanded version of Kaldor–Hicks efficiency as an axiomatic system that performs the following tasks: the new approach obviates certain technical and ethical criticisms that have been made of economic efficiency; it answers critics of efficiency; it allows an expanded range for efficiency analysis; it establishes the conditions under which economists can reasonably say that some state of the world is inefficient. He then applies the new analysis to a number of hard and fascinating cases, including the economics of duelling, cannibalism and rape. He develops a new theory of common law efficiency and indicates the circumstances under which the common law will be inefficient.
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Chapter 10: A Recapitulation

Richard O. Zerbe Jr.


10.1 THE KHZ CRITERION The standard criteria used to judge whether or not a public investment or a new law or regulation is desirable are referred to as the Kaldor–Hicks (KH) criteria. These represent two different potential compensation tests, one of which – Kaldor – is that a new investment or new law is desirable if the winners could compensate the losers for the loss. The Hicks test is that a project is worthwhile if the potential losers could not bribe the potential winners not to undertake the project. These criteria explicitly leave out distributional effects on two grounds: that their omission is necessary if a measure is to be scientific, and that whether compensation should take place ‘is a political question on which the economist, qua economist, could hardly pronounce an opinion’ (Kaldor 1939). However, the relationship between the various measures to actually be used (CVs, or compensating variations, and EVs, equivalent variations, and the WTP and the WTA) for welfare analysis and the compensation criteria is not straightforward, as Boadway and Bruce (1984) show and as I discuss in Chapter 3. The CV measures the value of a price change using final prices while the EV uses original prices. It was long thought that the CV measure was identical to the Kaldor compensation test and that the EV measure was identical to the Hicks test, but this is not in fact the case (Boadway and Bruce 1984). The use of the KH criteria has been subject to a...

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