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The Potential Compensation Principle and Constant Marginal Utility of Income

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  • Stephen Martin

    (Purdue University)

Abstract

In policy applications, industrial economists are wont to invoke the Kaldor—Hicks potential compensation principle to justify the use of deadweight loss as a measure of the welfare cost of market power. This usage rests on two assumptions. One of these assumptions, that changes in consumer and producer surplus are weighted equally, is well understood. The other assumption, that the marginal utility of income is constant, receives less attention. In a simple model, I show that if there is decreasing marginal utility of income, the use of deadweight loss as an index of market performance rests on shaky ground.

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  • Stephen Martin, 2019. "The Potential Compensation Principle and Constant Marginal Utility of Income," The Japanese Economic Review, Springer, vol. 70(3), pages 383-393, September.
    • Handle: RePEc:spr:jecrev:v:70:y:2019:i:3:d:10.1111_jere.12240
    DOI: 10.1111/jere.12240
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    References listed on IDEAS

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    4. Stephen Martin, 2019. "The Kaldor–Hicks Potential Compensation Principle and the Constant Marginal Utility of Income," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 55(3), pages 493-513, November.
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    Cited by:

    1. Stephen Martin, 2019. "The Potential Compensation Principle and Constant Marginal Utility of Income," The Japanese Economic Review, Springer, vol. 70(3), pages 383-393, September.
    2. Stephen Martin, 2019. "Economies as an Antitrust Defense: The Welfare Tradeoffs—Introduction to the Special Issue," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 55(3), pages 327-338, November.
    3. Stephen Martin, 2019. "The Kaldor–Hicks Potential Compensation Principle and the Constant Marginal Utility of Income," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 55(3), pages 493-513, November.
    4. Daniel Bauer & Darius Lakdawalla & Julian Reif, 2018. "Mortality Risk, Insurance, and the Value of Life," NBER Working Papers 25055, National Bureau of Economic Research, Inc.
    5. Glenk, Klaus & Meyerhoff, Jürgen & Colombo, Sergio & Faccioli, Michela, 2024. "Enhancing the face validity of choice experiments: A simple diagnostic check," Ecological Economics, Elsevier, vol. 221(C).

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    More about this item

    Keywords

    D61; L13;

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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