lecture8

# Lecture8 - Professor Jay Bhattacharya Spring 2001 Motivation for Welfare Analysis In the last class we found that the Consumer Price Index(CPI

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Professor Jay Bhattacharya Spring 2001 Econ 11--Lecture 8 1 Spring 2001 Econ 11--Lecture 8 1 Motivation for Welfare Analysis • In the last class, we found that the Consumer Price Index (CPI) overstates a “true” cost-of-living. without defining a “true” cost-of-living index. • Suppose, Initial situation: New situation: 0 0 0 , x I p H H Þ Is the consumer better off? 1 1 1 , x I p H H Þ Spring 2001 Econ 11--Lecture 8 2 • Is the consumer better off? – To answer this question, we need to make use of our utility framework. – Given both old and new prices and income, we can calculate the consumer’s demand for goods. – Then we plug these back into the consumer’s utility function (deriving the indirect utility function) and compare. – But utility is an ordinal measure, we want a cardinal measure so that we can know how much better (or worse) off the consumer is. – We want a “monetary” value of welfare. Spring 2001 Econ 11--Lecture 8 3 Three measures of the change in welfare • Compensating Variation (CV) • Equivalent Variation (EV) • Change in Consumer Surplus ( CS) Spring 2001 Econ 11--Lecture 8 4 Compensating Variation in Income (CV) • Given a price change from p 0 to p * what is the minimum income needed to get to the original level of utility, U 0 , at the new prices p * ? • “HowmuchmustIcompensateyoutomake you as well off as you were before the price change?” Spring 2001 Econ 11--Lecture 8 5 Compensating Variation in Income (CV) I 0 /P 2 X 2 X 1 Original budget constraint. Original Utility Level Budget constraint after price change. Budget constraint after utility is restored to the original level.

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## This note was uploaded on 02/11/2012 for the course ECON 51 taught by Professor Tendall,m during the Fall '07 term at Stanford.

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Lecture8 - Professor Jay Bhattacharya Spring 2001 Motivation for Welfare Analysis In the last class we found that the Consumer Price Index(CPI

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