CONSUMER SURPLUS
An important problem in applied welfare economics
is to devise a monetary measure of the
gains and losses that individuals experience when
prices change. One use for such a measure is
to place a dollar value on the welfare loss that peopl
Welfare Changes and the Marshallian Demand
Curve
So far our analysis of the welfare effects of price
changes has focused on the compensated demand
curve. This is in some ways unfortunate because most
empirical work on demand actually estimates
ordinary (M
REVEALED PREFERENCE AND THE
SUBSTITUTION EFFECT
The principal unambiguous prediction that can be
derived from the utility-maximation model is that the
slope (or price elasticity) of the compensated demand
curve is negative. The proof of this assertion rel
Engel Aggregation
We discussed the empirical analysis of market shares
and took special note of Engels law that the share of
income devoted to food declines as income increases.
From an elasticity perspective, Engels law is a
statement of the empirical re
Relationships among demand Elasticities
There are a number of relationships among the
elasticity concepts that have been developed
in this section. All of these are derived from the
underlying model of utility maximization.
Here we look at three such rela
DEMAND ELASTICITIES
So far we have been examining how individuals
respond to changes in prices and income by looking
at the derivatives of the demand function. For many
analytical questions this is a good way to proceed
because calculus methods can be dir
A MATHEMATICAL DEVELOPMENT OF
RESPONSE TO PRICE CHANGES
Up to this point we have largely relied on graphical
devices to describe how individuals respond to price
changes. Additional insights are provided by a more
mathematical approach. Our basic goal is
Indirect approach
To begin our indirect approach,4 we will assume (as
before) there are only two goods
(x and y) and focus on the compensated demand
function, xc.px , py ,U., introduced in
Equation 5.14. We now wish to illustrate the
connection between th
The Substitution Effect
Consequently, the derivative we seek has two terms.
Interpretation of the first term is straightforward: It is
the slope of the compensated demand curve. But that
slope represents movement along a single
indifference curve; it is,
The Consumer Surplus Concept
There is another way to look at this issue. We can ask
how much this person would be willing to pay for the
right to consume all of this good that he or she
wanted at the market price of p0x rather than doing
without the good