Consumer_surplus_Slides_630_2009_1st___2nd_part

# Consumer_surplus_Slides_630_2009_1st___2nd_part - Consumer...

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1 Consumer Surplus and Consumer Welfare No measure of well-being exists for utility maximizing consumers (unlike producer surplus where one can use an observable measure like profits) Utility not observable Can only observe prices, consumption and income Try to compute some money based measure of welfare Money reflects willingness to pay and is related to the utility function

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2 P o P 1 b a c d qo q1 D P Q If price declines to P 1 , then save area  b  in  income [inner cost or Laspeyers variation -  initial q] But if price increases to P o , then consumer pays  b  +  c  +  d  more [outer cost or Paasche  variation – final q] Paradox: consumers lose more with a price    split difference? (only in linear demand)
3 P o P 1 q o q 1 D P Q Approach 1: Sum of cost differences as price  continuously falls (Δ in consumer surplus) Suppose the price reduction is made in a series of small steps The corresponding income equivalents would be the shaded  areas The sum of the shaded area is the gain in consumer surplus If price changes more finely done, then entire area under the  demand curve and between the price lines becomes the  “consumer surplus” gain

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4 P* D Q P Approach 2: Excess of willingness to pay --wtp--  over actual payments (level of consumer  surplus) Change in wtp over what is actually paid \$ measure of welfare change Reflects only relative changes in utility Demand curve is the willingness to pay (wtp)  curve Consumer surplus only defined for price  changes with income and other shifters  fixed This leads to  uniqueness  problems
5 Path Dependency Problem of Consumer  Surplus · starting point P , m ↓ ↓ P m m , P ↓ ↓ m o m 1 P 1 P o < < < << << Consumer surplus under an ordinary or  Marshallian demand  curve (where income is held constant) is not well defined  if: several prices changes simultaneous change in price and income

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6 Consider: a price decrease from P o to P 1 and an income increase from m o to m 1 P↓, m↑ If ΔP 1 st , then ΔS = x + m 1 - m o m↑, P↓ If Δm 1st, then S = x + y + m 1 – m o ΔS of Rte A ≠ ΔS of Rte B (suggests differences in other paths
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Consumer_surplus_Slides_630_2009_1st___2nd_part - Consumer...

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