Edited by Mark Blaug and Peter Lloyd
Chapter 14: Community Indifference Curves and the Scitovsky ‘Paradox’
Richard G. Lipsey The Scitovsky ‘paradox’ was discovered early in the development of the ‘New Welfare Economics’ that began in the late 1930s.1 (For an excellent treatment of the evolution of welfare economics from its earliest days to the mid-1960s see Mishan (1967).) This new approach replaced the cardinal utility functions that were the basis of Pigovian welfare economics with ordinal welfare functions that made interpersonal comparisons of utility impossible and that came into British economics from the great Italian economist Vilfredo Pareto. When the full set of new welfare economics’ efficiency conditions were fulfilled, the result was a Pareto optimum in which it was impossible to raise one person’s welfare without simultaneously lowering at least one other person’s. A Pareto improvement was then defined as a change in which at least one person’s welfare was raised while no other person’s welfare was lowered, and it was accepted that such a change would raise the community’s overall welfare.2 A change that produced winners and losers would be a Pareto improvement if the gainers fully compensated the losers. To make their efficiency analysis applicable to those common cases in which losers were not fully compensated, a social gain was defined to occur if the gainers could, but not necessarily did, fully compensate the losers. This was the so-called hypothetical compensation test, (hereafter called the ‘h-c test’). Nicholas Kaldor (1939: 550) argued that economists could give policy advice based on whether or not a change satisfied the h-c test, but whether the...
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