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); (5) it obviates other important ethical objections that have been made to KH (Zerbe 1998b, 2001); (6) it eliminates the practice of finding market failure or inefficiency in situations in which in fact there is no superior alternative (Zerbe and McCurdy 1999).

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