Consumer Welfare and policy Flashcards
Consumer Surplus, Compensating Variation, Equivalent Variation
What is consumer surplus?
The difference between the maximum amount a consumer is willing to pay for the quanitity purchased and what the good actually costs.
If a consumer buys 3 magazines for £3 each is the utility they derive from each magazine equal?
How does this link to consumer surplus?
No, diminishing marginal utiltity means that the first magazine gives more utility than the last.
Therefore the price a consumer is willing to pay for n units of a good is based on the utility they derive from the last unit they bought.
On a graph, what area is the consumer surplus and what area is the expenditure?
Key point, the consumer pays the same for each unit reagardless of the diminishing utility, this makes consumer surplus highest for the first unit consumed.
When a price increases what does the decrease in consumer surplus show us?
The amount of income we would have to give the consumer to offset the harm of a price increase.
How does the PED affect changes in consumer surplus when price changes?
When demand is inelastic a price increase causes a bigger decrease in consumer surplus as the line is steeper.
When demand is elastic the change in consumer surplus is much smaller.
What demand curve is the theory of consumer surplus based on?
Consumer suplus is based on the Marshallian demand curve, also known as the compensated demand curve
What is the compensated demand curve?
The compensated demand curve is also known as the hicksian demand curve.
It shows:
- Demand without the income effect by compensating the consumer
- Thus only the substitution effect
What is the immediately noticeable difference between the Hicksian and Marshallian demand curves when put side by side?
The uncompensated demand curve will show that more is being consumed due to the lack of income effect.
What is an expenditure function? and what do they look like?
An expenditure function shows the minimum amount a consumer would have to spend to reach a chosen level of welfare (U bar), here at prices p1 and p2.
How can an expenditure function be used to show the change in welfare
The difference in how much it costs to maintain the original utility level at the new price, the equation for this is:
What are the alternatives measures of consumer welfare? (not consumer surplus)
- CV: Compensating Variation - The amount of compensation required for the consumer to stay on their original indifference curve after a price change.
- EV: Equivalent Variation - The amount of money we would have to take away from the consumer to harm them as much as the price increase did.
How are consumer surplus, Compensating variation and Equivalent variation different for price changes in normal goods?
For small price changes, they’re all very similar.
For more significant price changes:
CV > CS > EV
How are consumer surplus, Compensating variation and Equivalent variation different for price changes in inferior goods?
For small price changes, they’re very similar.
For more significant price changes:
CV < CS < EV
What is the best way for the government to give a subsidy?
It is always best for the government to give a lump sum payment
Show the effects of a tax on a consumer surplus diagram, include deadweight loss and revenues.
Consumer surplus is decreased by the area of both below
There is a deadweight loss (red triangle)
There is tax revenue (brown rectangle)
Show the effects of a tax for perfectly inelastic demand on consumer surplus.
Include revenues and deadweight loss.
How will a tax affect inelastic and elastic demand differently?
There is no deadweight loss when taxing a perfectly elastic good.
This tells us that the more inelastic the demand, the lower the deadweight welfare loss and the less effect the tax will have on consumption. However, there will be more tax revenue.
