5-Consumer Theory (III)

5-Consumer Theory (III) - 9/1/2010 Agenda Course Overview...

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9/1/2010 1 Agenda • Course Overview • Consumer Surplus • Demand Estimation • What To Take Away Microeconomics The Structure of the Course Consumers and Producers Market Interaction Today’s lecture Uncertainty Perfect competition Monopoly and Pricing strategies Competitive Strategy Auctions Information in Markets and Agency Game Theory Introduction to Markets Consumer Theory and Demand Technology and Production
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9/1/2010 2 Agenda • Course Overview • Consumer Surplus • Demand Estimation • What To Take Away Consumer surplus So far we have discussed how a consumer behaves under different market conditions. In this sense, our analysis so far has been positive (behavioral) . In some instances we would also like to perform a normative analysis: We would like to know if certain policies, or general changes in the economic environment, are good for consumers or not. Taking an individual consumer it would in principle be easy to assess whether the consumer is made “better off” or “worse off” by a given policy: if his utility has increased as a result of implementation of the policy the consumer is certainly made better off. In particular we followed this approach when looking at the impact of rationing in the gasoline market. In many instances, however, this is not enough. We maybe interested in performing a cost-benefit analysis of a particular policy where the benefit of the policy may come from raising the well-being of the consumer or the cost comes from reducing it. In this sense we need a measure of “how much” better off (or worse-off) is a consumer made by the introduction of policy.
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9/1/2010 3 Consumer surplus One maybe tempted to “measure” the change in the well-being of an individual by looking at the difference in his utility as a result of the policy. Why is this a bad idea? Indeed, utility only provides a ranking of the options available to a consumer. In particular, multiplying the utility function by a positive number would provide the same ranking but will give us a different answer in terms of the “benefit” to the consumer! Instead, if the policy increases the well-being of the consumer we could ask her what would be the maximum amount of wealth she would be willing to give up to implement the policy, or if the policy hurts the consumer we could ask her what is the minimum amount of wealth that the consumer would need to accept the policy. In essence, we are asking what is the amount of income require after the implementation of the policy to leave her indifferent with not implementing the policy. This is called “ the compensating variation ”. Compensating variation Suppose that the new policy is a decrease in the price of food from p to p’ , Food (units per month) O Clothing (units per month) x 1 1/p y 1 A Therefore the consumer would be willing to pay up to CV for a price reduction in Food. Note that CV is precisely the rise in income under the income effect !
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5-Consumer Theory (III) - 9/1/2010 Agenda Course Overview...

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