Problem Set 3 Solutions

Note that since x is on the horizontal axis and px is

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Unformatted text preview: = 30*ln(1.25) = 6.69, which is between the CV and the EV, as expected. Note that since X is on the horizontal axis and Px is on the vertical, the integral is actually the area to the left of the curve, not the area under the curve as we normally draw definite integrals. e) Recall from part (a) that the CV represents the amount of money that people would accept after a price increase in order to take them back to their original utility, while EV is the amount of money people would pay before a price increase in order to avoid it. EV and CV generally differ because the value of money is different before and after the price change. It may be easier to think in terms of inflation, which recall is just an increase in prices across the board. Suppose that after inflation occurs, the government asks consumers how much money they require in order to bring them back to the previous year’s utility level. That amount would be the CV. Similarly, the government can ask people before inflation occurs how much money they would be willing to pay in order for the government to prevent inflation – this is the EV. But the two amounts will differ because the value of money after inflation is not the same as before inflation....
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