Editing Kaldor–Hicks efficiency (section)

==Use in policy-making==
The Kaldor–Hicks methods are typically used as tests of potential improvements rather than as efficiency goals themselves. They are used to determine whether an activity moves the economy toward Pareto efficiency. Any change usually makes some people better off and others worse off, so these tests consider what would happen if gainers were to compensate losers.

The Kaldor criterion is that an activity moves the economy closer to Pareto optimality if the maximum amount the gainers are [[willingness to pay|prepared to pay]] to the losers to agree to the change is greater than the minimum amount losers are prepared to accept; the Hicks criterion is that an activity moves the economy toward Pareto optimality if the maximum amount the losers would pay the gainers to forgo the change is less than the minimum amount the gainers would accept to so agree. Thus, the Kaldor test supposes that losers could prevent the arrangement and asks whether gainers value their gain so much they would and could pay losers to accept the arrangement, whereas the Hicks test supposes that gainers are able to proceed with the change and asks whether losers consider their loss to be worth less than what it would cost them to pay gainers to agree ''not'' to proceed with the change. After several technical problems with each separate criterion were discovered, they were combined into the [[Scitovsky]] criterion, more commonly known as the "Kaldor–Hicks criterion", which does not share the same flaws.

The Kaldor–Hicks criterion is widely applied in [[game theory]]'s non-zero sum games, such as [[DOTMLPF]], [[welfare economics]], and [[managerial economics]].  For example, it forms an underlying rationale for [[cost–benefit analysis]].  In cost–benefit analysis, a project (for example, a new airport) is evaluated by comparing the total costs, such as building costs and environmental costs, with the total benefits, such as airline profits and convenience for travelers. (However, as cost–benefit analysis may also assign different social welfare weights to different individuals, e.g. more to the poor, the compensation criterion is not always invoked by cost–benefit analysis.)

The project would typically be given the go-ahead if the benefits exceed the costs.  This is effectively an application of the Kaldor–Hicks criterion because it is equivalent to requiring that the benefits be enough that those that benefit could in theory compensate those that have lost out.  The criterion is used because it is argued that it is justifiable for society as a whole to make some worse off if this means a greater gain for others.