Chapter 5 - Consumers Surplus

Chapter 5 - Consumers Surplus - Chapter 5 Price changes and...

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Chapter 5 Price changes and consumer welfare In the previous chapter, we developed some means for dealing with questions such as: how much income must a consumer be given to compensate the consumer for utility lost due to an increase in price? In this chapter, we will be asking two related questions: how much additional income would a consumer take to accept a price increase? And: how much income would a consumer surrender to be rid of a price increase? The answers to these questions are very similar to the answers to the related questions in the previous chapter, but these new questions get directly to the point. What someone is willing to take to give up something, or what someone is willing to pay to obtain something are natural dollar measures of value, and therefore coming up with a monetary measurement of what the consumer will pay (or accept) to take (or be rid) of a price change allows us to pin down the consumer’s monetary valuation of price changes. We will see in this chapter that if we want to know how consumers are impacted by price changes, we should look to compensated demands and the expenditure function. This is diFerent than the approach taken in most principles-of-micro courses, within which the treatment of the subject relies on consumers’ surplus. Technically, consumers’ surplus is not an exact measure of (the dollar value of) utility lost or gained due to a price change, 139
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140 CHAPTER 5. PRICE CHANGES AND CONSUMER WELFARE but we will also see that it is in many cases not a bad approximation to actual measures of the dollar value of utility lost or gained due to a price change. 5.1 Consumers’ Surplus In a standard principles of economics course, one learns how to use the demand curve to assess consumer welfare before and after price changes. The fundamental idea underlying the use of consumers’ surplus is that it is apparently a measure of excess utility earned by the consumer (or a mass of consumers) from participating in a market. To motivate the idea, consider the following story. When I Fnished graduate school, I got a job and was able to acquire better clothes, some of which required ironing, so I felt it would be a good idea to buy an iron. I went to Walmart to purchase an iron, but really had no idea how much one would cost, given that I had been living in the vacuum of graduate school for several years, and had therefore lost all contact with the civilized world. I’m not sure where my beliefs came from, but I remember thinking to myself, as I walked into Walmart: “I’m guessing an iron is going to cost about $ 25 ... and that’s about all I really want to pay for an iron.” Much to my delight, however, I was able to buy a reasonable iron for about $ 10, which was a full $ 15 lower than what I would have been willing to pay for the iron. If Walmart charged $ 25 for the exact iron I wound up purchasing, I would have paid this higher price, and I would have been deprived of a good anecdote about consumers’ surplus. What does this example illustrate? That I was able to buy an object for
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This note was uploaded on 11/13/2009 for the course ECONOMICS 721 taught by Professor Partha during the Fall '09 term at CUNY Hunter.

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Chapter 5 - Consumers Surplus - Chapter 5 Price changes and...

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