CV_vs_EV - CV EV If the demand for good 1 is inferior: 0 EV...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Compensating vs. Equivalent Variation Notation: p 0 old price vector p 1 new price vector u 0 old level of utility u 1 new level of utility Indirect utility at old prices vp 0 , w () = u 0 Indirect utility at new prices vp 1 , w () = u 1 For simplicity, assume that only the price of good 1 changes from p 1 0 to p 1 1 . p ± 1 denotes all prices other than p 1 , which are assumed to stay constant. Compensating Variation (CV) Equivalent Variation (EV) Algebraic Definition CV = ep 1 , u 1 () ± ep 1 , u 0 () = ep 0 , u 0 () ± ep 1 , u 0 () = w ± ep 1 , u 0 () = h 1 s , p ± 1 , u 0 () s = p 1 1 p 1 0 ² ds EV = ep 0 , u 1 () ± ep 0 , u 0 () = ep 0 , u 1 () ± ep 1 , u 1 () = ep 0 , u 1 () ± w = h 1 s , p ± 1 , u 1 () s = p 1 1 p 1 0 ² ds vp 0 , w () = vp 1 , w ± CV () vp 0 , w + EV () = vp 1 , w () In the case of a price drop or subsidy (i.e. a negative tax): Compensating Variation (CV) Equivalent Variation (EV) Thought Experiment What is the maximum the consumer would be willing to pay to get the price drop or subsidy? How much would the consumer be willing to accept in lieu of the price drop or subsidy? Normal Good Normal Good Graphs Inferior Good Inferior Good Magnitudes/ Signs If the demand for good 1 is normal: 0
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: CV EV If the demand for good 1 is inferior: 0 EV CV In the case of a price increase or a tax: Compensating Variation (CV) Equivalent Variation (EV) Thought Experiment What is the maximum the consumer would be willing to pay to get the price increase or tax? (A negative amount!) How much would the consumer be willing to accept in lieu of the price increase or tax? (Again, a negative amount!) Normal Good Normal Good Graphs Inferior Good Inferior Good Magnitudes/ Signs If the demand for good 1 is normal: CV EV If the demand for good 1 is inferior: EV CV Note: The diagrams for inferior goods depict Giffen Goods, very inferior goods. (As prices increase, demand increases.) The same CV/EV relationships hold for inferior goods that are not Giffen....
View Full Document

Page1 / 2

CV_vs_EV - CV EV If the demand for good 1 is inferior: 0 EV...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online