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ECON203 Microeconomic Analysis 2010 1 Lecture 3: Consumer welfare (some material continued from Lecture 2)
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ECON203 Microeconomic Analysis 2010 2 Income and substitution effects: Ordinary good ( q 1 , normal) 2 x 1 p increase) price ( Y 1 p ICC PCC 0 p Y 1 q 1 q I S G 1 q ( 29 Y , p , p D q 2 1 1 1 = ( 29 Y , p , p d q 2 1 1 1 =
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ECON203 Microeconomic Analysis 2010 3 Ordinary (Marshallian) demand functions Ordinary (Marshallian) demand functions: quantities demanded at all prices and incomes. ( 29 ( 29 Y , p , p D q , Y , p , p D q 2 1 2 2 2 1 1 1 = = Ordinary demand functions contain both the income and substitution effects Ordinary demand functions are directly observable in data
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ECON203 Microeconomic Analysis 2010 Compensated (Hicksian) demand functions Compensated (Hicksian) demand functions: q prices and utility levels ( 29 ( 29 u , p , p H q u , p , p H q 2 1 2 2 2 1 1 1 = = Compensated demand functions contain only the substitution effects. Compensated demand functions are can be inferred from data given an explicit utility function
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ECON203 Microeconomic Analysis 2010 5 Compensated demand functions. The following diagrams shows the derivation of compensated demand function for q 1 ( 29 u p p H q 2 1 1 , = Just as ordinary demand functions can be defined for any given level of income, Y , so compensated demand functions can be defined for any given level of utility, u . It is common to focus on either the compensated demand function defined on the initial utility u 0 or on the utility level after the price change, 1 u .
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ECON203 Microeconomic Analysis 2010 6 Compensated demand functions. relative to U 0 1 p let 2 = 2 q Y 1 p 1 1 p 0 1 p 1 1 p 0 1 p 0 u 1 u 1 q 1 q ICC I S compensated demand ordinary demand function
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ECON203 Microeconomic Analysis 2010 7 Compensated demand functions. relative to U 1 1 p let 2 = 2 q Y 1 p 1 1 p 0 1 p 1 1 p 0 1 p 0 u 1 u 1 q 1 q ICC I S compensated demand ordinary demand function
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ECON203 Microeconomic Analysis 2010 8 Estimates of demand elasticities Canada Greece U.K U.S Compensated Price Elasticities Food -0.54 -0.31 0.00 a -0.87 b Clothing -0.81 -0.14 -0.94 -1.31 Housing na -0.57 c -0.30 -0.39 Fuel -0.61 na -0.08 -0.54 Transport & Communication -0.71 -0.74 -1.17 -0.67 d Durables na -0.67 na -0.93 Income Elasticities Food 0.27 0.91 0.17 a 0.95 b Clothing 0.04 1.40 2.92 1.34 Housing na 0.84 c -0.02 0.76 Fuel 1.64 na 0.86 1.21 Transport & Communication 1.57 0.98 1.05 1.35 d Durables na 1.17 na 1.48 Sources: Canada Anderson and Blundell 1983, Greece: Mergos and Donatos 1989, U.K. Deaton and Muelbauer 1980, U.S. Taube and MacDonald 1991
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