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Perloff_397614_IM_Ch05 - Chapter 5 Consumer Welfare and...

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Chapter 5 Consumer Welfare and Policy Analysis Chapter Outline 5.1 Consumer Welfare Measuring Consumer Welfare Effect of a Price Change on Consumer Surplus 5.2 Expenditure Function and Consumer Welfare Indifference Curve Analysis Comparing the Three Welfare Measures 5.3 Market Consumer Surplus Loss of Market Consumer Surplus from a Higher Price Markets in Which Consumer Surplus Losses Are Large 5.4 Effects of Government Policies on Consumer Welfare Quotas Food Stamps 5.5 Deriving Labor Supply Curves Labor-Leisure Choice Income and Substitution Effects Shape of the Labor Supply Curve Income Tax Rates and Labor Supply Teaching Tips The material in Chapter 5 introduces the concept of consumer welfare and illustrates the concept using a some applications of government policies that alter the equilibrium and so also change overall welfare. From the consumer standpoint, you might want to emphasize the difference between the marginal utility, average utility, and total utility. Students should understand that statements such as I bought these ten candy bars for $1 each because that’s how much each is worth to me are incorrect. By spending the $10 on the candy, they reveal that the last candy bar is worth $1 to them; the previous units are worth more, and the difference is consumer surplus. Not all students will have been exposed to integrals in the introductory calculus class, so this may need explaining in more detail. Students are often confused by the difference between compensating and equivalent variation, and even those that grasp the concept often calculate the wrong one. It is useful to show the similarity between the CV (Figure 5.3) and the Hicksian decomposition (Figure 4.5).
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60 Perloff • Microeconomics: Theory and Applications with Calculus The inclusion of the labor supply curve and the labor leisure trade-off in this chapter is another good way to make the point of the importance of the substitution and income effects. Although it has been extended and refined in recent years by the inclusion of home production effects, Ashenfelter and Heckman’s paper ( Econometrica , January 1974) on the income and substitution effects of family income is a nice empirical test of this concept. Briefly, they found that women treat increases in their husband’s income as a pure income effect (i.e., they “purchase” more leisure by reducing work hours), but husbands do not react to an increase in their wife’s income (indicating an income effect of zero). Students are likely to have their own opinions on the validity of this result in today’s labor market, which can lead to a lively discussion. The effect of income taxes on labor supply is also a good discussion topic. The text describes the attempts by the Kennedy, Reagan, and George W. Bush administrations to increase both work effort and tax receipts by decreasing marginal tax rates at the highest levels. If there is time, you might point out the normative nature of “fair” marginal tax rates, and that while a primary issue for individuals is fairness, another important aspect of the setting of tax rates is how they may affect work effort and thus revenues.
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