lecture7 - welfare

lecture7 - welfare - Topic 4: Consumer Choice (3) From...

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opic 4: Consumer Choice (3) Topic 4: Consumer Choice (3) From demand to welfare USC Marshall
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Homework 35 30 20 25 10 15 0 5 USC Marshall 40 40>x>=35 35>x>=30 x<30
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From demand to welfare • Having discussed how demand is formed, we can discuss how changes in market conditions affect consumer welfare • But if levels of utility have no meaning, how can we talk about welfare? USC Marshall
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From demand to welfare • Having discussed how demand is formed, we can discuss how changes in market conditions affect consumer welfare • But if levels of utility have no meaning, how can we talk about welfare? – We can still analyze: • Whether a consumer is better off or worse off • What would it take to make a consumer as well off as before a change USC Marshall
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From demand to welfare How can we evaluate consumer welfare? – From consumer preferences • Compensating variation – From demand curves • Consumer surplus –Compensated and uncompensated demand curves – From the evolution of prices • Price indices USC Marshall
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From demand to welfare An example: – The government can introduce a new education program, at the cost of $100. Tom would accept a reduction of $75 in his income in return for this policy while Helen would accept a reduction of $40. Matt, on the other hand, is worse off and needs to e compensated $x if the policy is implemented. be compensated $x if the policy is implemented. For what values of x can we make the positive statement that the policy should be implemented? USC Marshall
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From demand to welfare Answer: – Tom and Helen are willing to pay a total of $75+$40=$115 for the policy. After the cost of $100, we are left with $15 surplus. Thus, as long as x<$15, we can compensate Matt for his loss. Thus, everybody can be made at least as well off s before the policy. as before the policy. – If x>$15, the policy can still be desirable, depending on how we weigh the well-being of the different consumers – it becomes a normative question USC Marshall
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From demand to welfare How can we get the numbers? – Logic: • Consumer preferences tell us the tradeoff between prices and income (and potentially other variables) • Thus, we can establish a dollar amount that ould either be taken away from a consumer or could either be taken away from a consumer or needs to be given to a consumer to make him or her equally well off as before the change • If we can distribute income so that everybody is better off, then we can make a positive USC Marshall statement that the change is desirable
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From demand to welfare Compensating variation: – The amount of compensation (positive or negative) that is needed to make a consumer as well off as before a change in the market conditions – In the case of price changes, compensating variation is simply the negative of the income effect USC Marshall
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Compensating variation Q Y A B B' Income effect Q X I/P X I/P' X I'/P' X Substitution effect USC Marshall
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Compensating variation Q Y A B B' Income effect Δ I = compensating variation ( how much we could reduce the
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lecture7 - welfare - Topic 4: Consumer Choice (3) From...

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