The "Boadway Paradox" revisited

Abstract

The "Boadway paradox" identifies potential Pareto improvements in a general equilibrium setting when none exist. It finds the compensating variations (CV.s) for a lump-sum redistribution of income have a positive sum. Clearly, this undermines the credibility of a conventional cost-benefit analysis. If it cannot reliably separate income and substitution effects, then it cannot be used to identify potential welfare gains in project evaluation. This paradox occurs when CV.s are computed at non-market clearing prices. It is avoided by allowing prices to clear markets in the compensated equilibrium.