L6ImpactofChanges

L6ImpactofChanges - Introductionto Microeconomics Lecture6

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1 Introduction to Microeconomics Lecture 6 Measuring the Impact of Changes Ian Crawford Outline z Often in applied work (esp. policy evaluation) we want to know the effects which price changes have on consumers’ welfare. z E.g. Indirect tax reform, tariffs, climate change levy, inflation . .. z Will consumers be better/worse off on average; who are winners/losers? How do we measure the gains/losses? Health Warning! z We have stressed that utility representations of preferences are ordinal. z When prices change and the consumer re optimises we can say whether they are better off or worse off or the same. z But if we want to ask “how much better off are they?” and compare the answer across consumers we are entering the somewhat murky world of util counting. Plan z Theory: Measuring economic welfare. z Compensating and Equivalent Variation z Cost of Living Indice Cost of Living Indices z Practice: Measurement and approximations z Consumer surplus
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2 Measuring Economic Welfare z We need z a coherent way of labelling indifference curves z some convenient units z We label indifference curves with the (minimum) expenditure required to reach that particular level of utility, at some reference prices. Measuring Economic Welfare 2 x An arbitrary indifference curve Utility number is u u 1 x Measuring Economic Welfare 2 x An arbitrary budget line. The slope is given by the relative prices , the location by the expenditure { } 12 , pp u 1 x level m Remember: parallel movements of the budget constraint equate to changes in the budget We can find the minimum expenditure required to reach u by shifting the budget line inwards, parallel until it just touches the indifference curve. Measuring Economic Welfare 2 x u 1 x
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3 The answer ( m ) is the minimum budget required to reach u given the reference prices Measuring Economic Welfare 2 x { } 12 , pp i) The reference prices - ii) The position of the indifference curve - u u 1 x { } , z As usual we can vary both the reference prices and u (i.e. the indifference curve of interest) and work out the required expenditure each time. z As usual this will trace out a function mapping Measuring Economic Welfare { } , { } ,, ppu to . We denote this by z This is called the “ expenditure function” (or “cost function” ) z It tells us the minimum expenditure required to reach any given level of utility at any reference prices m () mp p u Measuring Economic Welfare 2 x For these reference prices (i.e. the ones which define the slope of this budget constraint) we label the budget line which is just tangent to the indifference curve by the minimum spending u 1 x required to reach it: Measuring Economic Welfare 2 x Now suppose we’ve got two IC’s.
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L6ImpactofChanges - Introductionto Microeconomics Lecture6

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