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The criterion for economic efficiency is known as Pareto Optimality. When an economy has reached this state it is impossible to rearrange the system to benefit one person without causing harm to another. To maintain this maximum level of efficiency it is accepted that no policy should be adopted unless it's overall benefits outweigh the aggregate of its costs to society. This is fair and theoretically follows the Pareto criterion because as long as the benefits outweigh costs, those considered gainers have the potential to compensate so-called losers (creating a situation in which there are only winners). This is known as the compensation criterion
The compensation criterion simply allows for the potential of compensation, whether it should be paid or how is left to be addressed as a separate ethical discussion. Also, a person's willingness to pay for something is directly related to their income level or ability to pay. As result, wealthier individuals' desires receive more attention in the compensation criterion.
Another economic problem with the environment is unclear property rights to common pool resources, such as air and water. To avoid a market failure that could be caused by for example, unlimited pollution, the government creates artificial incentives to limit pollution through regulations, taxes, and subsidies. One example is the formation of environmental quality standards (EQS). EQS are legally established levels of acceptable cleanliness. The Pareto optimality principle is used to determine EQS because the willingness to pay to clean up the environment is directly related to citizens' willingness to pay for the improvement.
The problem with the economic approach to standard setting is that there comes a point at which cleaning up the environment is much too costly. This means that there will always be an acceptable level of pollution and that eliminating pollution completely is not possible. Another problem is that cost benefit analysis is not exactly fair because it requires no sacrifice from those who benefit and provides no compensation to those who lose out in the standards that are set. This creates a cycle in which gainers are constantly calling for stricter standards and losers for more relaxed regulation.
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