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Unformatted text preview: Economics 101Lecture 8 Consumer Surplus and Revealed Preference George J. Mailath February 8, 2011 In our last episode 1 We studied the labor/leisure decision of a worker, as an illustration of substitution and income effects. 2 Compensating variation of a change from p to p is ( u = V ( p , I ) ) given by CV ( p p ) = e ( p , u ) e ( p , u ) (suppose only the price of good 1 changes and p 1 > p 1 ) = p 1 p 1 e ( p , u ) p 1 dp 1 = p 1 p 1 x c 1 ( p , u ) dp 1 . 3 What if p 1 < p 1 ? Elasticities Consider a demand function x i ( p , I ) . How does expenditure p i x i ( p , I ) respond to a change in price p i ? p i x i ( p , I ) p i = x i + p i x i p i = x i 1 + p i x i x i p i = x i { 1 i } , where i is the (own) price elasticity of demand (for good i ): i = p i x i x i p i . unit elasticity if i = 1, so revenue unchanged, Demand is elastic if i is big, so revenue , Demand is inelastic if i is small, so revenue . Returning to compensating variation CV ( p p ) = p 1 p 1 x c 1 ( p , u ) dp 1 . Some intuition Suppose compensated demand is very inelastic. Some intuition Suppose compensated demand is very elastic. Consumer Surplus...
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This note was uploaded on 03/02/2011 for the course ECON 101 taught by Professor Dannicatambay during the Spring '08 term at UPenn.
 Spring '08
 DANNICATAMBAY
 Microeconomics, Consumer Surplus

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