t - 1 WELFARE PROPERTIES OF MARKETS Consumer's Surplus...

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1 WELFARE PROPERTIES OF MARKETS Consumer’s Surplus [Money-Metric Utility] The purpose of this handout is to describe how economists measure changes in consumer WELFARE in response to PRICE CHANGES . The problem is: 1. Consumer welfare/satisfaction is measured in terms of utility. 2. Utility is not observable. 3. Prices themselves do not affect utility. 4. We would like to talk about welfare in terms of something measurable , say, $. Recall also that a downward-sloping demand curve reflects the principle of diminishing marginal utility (PDMU). For example: IF a producer was able to charge incremental prices , she could extract the consumer’s willingness to pay for each drink. In this way she could charge $2.40 for the 5 th drink, $2.00 for the 6 th drink, and $1.00 for the 10 th drink, etc. P Q 5.5 4.0 2.0 5 6 10 D The consumer is willing to pay $5.50 for the 5 th drink. The consumer is willing to pay $4.00 for the 6 th drink. The consumer is willing to pay $2.00 for the 10 th drink.
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2 Yet consumers generally face uniform prices – a constant price for all units purchased. This has the important implication that the consumer receives a surplus (of utility) because she is paying less than her marginal willingness to pay (MWTP) for all but the last unit consumed. This
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t - 1 WELFARE PROPERTIES OF MARKETS Consumer's Surplus...

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