1. lead to an increase in efficiency in the sense that everyone can be made better off.
2. make everyone better off because the gainers can fully compensate the losers and still be better off.
3. make society better off if a dollar is worth the same to every gainer as it is to every loser.
4. do all of the above.
Choose the option that yields the correct answer.
The correct choice is option 1. Everyone can be made better off. If an appropriate compensation of the losers is not made, everyone is not in fact better off, so option 2 is an incorrect choice. To argue that society is better off even though some individuals in it are left worse off, we have to be able to argue that the gains to the gainers are worth more to society than the losses of the losers. One could try to argue that an extra dollar to a gainer is worth the same to society as an extra dollar to a loser and that society therefore gains. Even if each gainer gets the same benefit from an extra dollar as each loser, as option 3 suggests, however, society may think that some people (for example, the poor) are more entitled to an additional dollar than others.
This last issue deserves further comment. Many years ago, some economists thought that peoples' marginal benefits from additions to their income get smaller and smaller as their incomes rise. It thus seemed reasonable that societies' welfare could be increased by taking income from people with high incomes, who are getting low marginal benefits from additional income, and giving it to low-income people, who are getting high marginal benefits. Since the low-income people would gain more from the marginal dollar shifted than high-income people would lose, the net benefit from shifting income from rich to poor would be positive.
There are three problems with this argument. The first problem is that there is no basis for assuming that everyone's marginal benefit from additional income declines as their level of income increases---no measures of marginal benefit have ever been made. This leads directly to the second problem. No measure of marginal (or total) benefit to individuals from consumption can ever be made. One's benefit from a given dollar of income or consumption is in one's own mind. Who is to say that person A gets more benefit from any activity than person B does? The third problem is that society need not agree that all people are equally entitled to whatever benefits an additional dollar will give them---this requires a value judgment. Economists cannot impose value judgments on society.