Lecture05 - Lecture 5: Consumer Welfare Perlo Chapter 5...

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Lecture 5: Consumer Welfare Perlo/ Chapter 5 Vladimir Petkov VUW 15 March 2010 Vladimir Petkov (VUW) Lecture 5: Consumer Welfare 15 March 2010 1 ± 25
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Measuring Consumer Welfare in excess of the cost of that good. Consumer surplus : the di/erence between what the consumer is willing to pay and what he actually pays. Vladimir Petkov (VUW) Lecture 5: Consumer Welfare 15 March 2010 2 ± 25
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The E/ect of a Price Increase in Consumer Surplus When the price goes up, consumer surplus decreases. Two reasons for the fall in CS: 1 There are some units he would have bought before, but not after the price increase. 2 He would have to pay a higher price for all the units he would still buy. Vladimir Petkov (VUW) Lecture 5: Consumer Welfare 15 March 2010 3 ± 25
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Demand Elasticity and Changes in Consumer Surplus A price increase will cause a bigger loss in consumer surplus when demand is more inelastic . Vladimir Petkov (VUW) Lecture 5: Consumer Welfare 15 March 2010 4 / 25
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The Expenditure Function and Consumer Welfare Another useful measure of consumer welfare is the income we have to give a buyer to just o/set the harm of a price increase. That is, how much extra income do we need to give the consumer to enable him to remain on a certain indi/erence curve. For this measure we cannot use the uncompensated demand curve, as utility changes along that curve. Thus, we have to use compensated demand. Alternatively, we can use the expenditure function E . Remember, E utility ¯ U when prices are p x , p y : E = E ( p x , p y , ¯ U ) . If the price of good x changes from p x to p x , to maintain utility ¯ U our income needs to change by E ( p x , p y , ¯ U ) ± E ( p x , p y , ¯ U ) . Vladimir Petkov (VUW) Lecture 5: Consumer Welfare 15 March 2010 5 ± 25
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Expenditure and Welfare (Continued) With this approach, we need to decide which level of utility, ¯ U , to use. Compensating variation (CV). The extra income a consumer needs to get to o/set completely the harm of a price increase. The reference utility level ¯ U is that before the price increase. We keep the consumer on the old indi/erence curve. Equivalent variation
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Lecture05 - Lecture 5: Consumer Welfare Perlo Chapter 5...

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