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07. Consumer Surplus

07. Consumer Surplus - Consumer Surplus Professor John...

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Consumer Surplus Professor John Diamond ECON 370: Microeconomic Theory Lecture 7

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2 Measuring the Gains from Trade Consumers gain from trading at single price (by avoiding perfect price discrimination) Need a measure of these gains from trade NOT a marginal concept Want total dollar value of entering market Calculated for market quantity purchased Reflects max willingness to pay to enter market Ideally, want utility-based measure But typically use observed market quantities
3 Three common measures of gains from trade Approximate (common) measure Consumer’s Surplus (CS) (Marshallian CS) Exact measures Equivalent Variation (EV) Compensating Variation (CV) Generally, give somewhat different answers But identical for quasi-linear utility function Dollar Measures of Gains from Trade

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4 Measure marginal utility gain as willingness to pay for marginal unit Suppose gasoline bought only in gallons Reservation price ( r 1 ) of 1 st gallon = max consumers would pay for 1st gallon = dollar equivalent of MU 1 st gallon Same for r 2 thru r n Dollar Equivalent Utility Gains
5 r 1 + … + r n = dollar equivalent of total change in utility from n gallons at zero price r 1 + … + r n - p G n = dollar equivalent of total change in utility from n gallons of gasoline at unit price of \$p G Reservation-price curve plot of r 1 , r 2 , … , r n , … against n not identical to consumer’s demand curve Dollar Equivalent Utility Gains

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6 (\$) Res. Values 0 2 4 6 8 10 Gasoline (gallons) 1 2 3 4 5 6 r 1 r 2 r 3 r 4 r 5 r 6 Reservation Price Curve for Gasoline Dollar Equivalent Utility Gains
7 Dollar equivalent net utility gain from trading in gas market at \$p G For 1 st gal = \$(r 1 - p G ) For 2 nd gal = \$(r 2 - p G ) , etc. Total dollar value of gain from trade =

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07. Consumer Surplus - Consumer Surplus Professor John...

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