lecture7 - welfare - handout

lecture7 - welfare - handout - 2/1/2009 Topic 4: Consumer...

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2/1/2009 1 Topic 4: Consumer Choice (3) USC Marshal From demand to welfare 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 USC Marshal 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 From demand to welfare How can we evaluate consumer welfare? – From consumer preferences • Compensating variation – From demand curves • Consumer surplus USC Marshal –Compensated and uncompensated demand curves – From the evolution of prices • Price indices
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2/1/2009 2 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 USC Marshal Matt, on the other hand, is worse off and needs to 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? 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 USC Marshal Thus, everybody can be made at least as well off 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 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) USC Marshal • Thus, we can establish a dollar amount that 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 statement that the change is desirable
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2/1/2009 3 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
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This note was uploaded on 04/07/2009 for the course BUAD 351 taught by Professor Eastin during the Spring '07 term at USC.

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lecture7 - welfare - handout - 2/1/2009 Topic 4: Consumer...

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