Consumer Welfare + Intertemporal Choices Flashcards
What is Consumer Surplus?
Measure of benefits obtained from Consuming certain units of a good
Where on a diagram is Consumer Surplus represented?
Area under Demand Curve
What does Consumer Surplus say for each unit of a good?
Consumer is willing to pay a reservation Price
But only Pays Market Price
What is the Total Loss to a Consumer due to a Price Increase on a Diagram?
A + B
A = x’ (p’ - p)
B = 0.5 (x - x’) (p’ - p)
In terms of Loss to Consumer, what is A = x’ (p’ - p)?
A = Additional Amount Consumer pays for units they continue to Consume
In terms of Loss to Consumer, what is B = 0.5 (x - x’) (p’ - p)?
B = Reduction in amount of Consumption
What is Compensating Variation (CV)?
Measures how much Extra Income Consumer must Receive to be compensated for Price change
- Amount of extra income needed to be just as well off as before Price Change
What is Equivalent Variation (EV)?
Measures Max. Amount of Income Consumer is Willing to pay to avoid the Price Change
- Amount of Income Taken away before Price Change to be as well off as After Price Change
For an Increase in Price of Good 1, what happens to the graph for CV?
New I.C is Lower
- B.C parallel to B.C2 but Tangent to I.C1
=> Gives New Income at Initial Prices (Initial Consump. Bundle) with Same Price Ratio as New Bundle
For an Increase in Price of Good 1, what happens to the graph for EV?
New I.C is Lower
- B.C parallel to B.C1 but Tangent to I.C2
=> Gives New Income at New Prices with Same Price Ratio as Initial Bundle
Given Utility Function, Initial Prices + Income & Price Change
=> How do you find CV + EV?
- Compute Demand Function of x1 + x2: p1x1 + p2x2 = m
+ Calculate MRS - Compute Consumption Choices at Initial + New Prices using Utility Func.
- Calculate CV - Utility Bundle w/ Income = m’ + New Prices
- Calculate EV - Utility Bundle w/ Income m’ + Initial Prices
When does CV = EV = dCS ALWAYS apply?
Quasilinear Functions
What happens to EV, CV and dCS if Utility Function is NOT Quasilinear?
EV < dCS < CV
What does Intertemporal Choice do?
Accounts for Saving, Lending + Borrowing
What is Intertemporal Choice made up of?
2 Time Periods - t1 + t2
Consumption in each Period - c1 + c2 (Suppose Price of Consump. = 1)
Income Available in each Period - m1 + m2
What 3 Choices does Consumer have for Intertemporal Choice?
Must make Choice Today
c1 = m1 & c2 = m2
c1 < m1 - Save for t2
c1 > m1 - Borrow Money + Pay back in t2
If Consumer Saves in t1 - what is c2 + the B.C?
Saving in t1 - c1 < m1
t2 : c2 = m2 + (m1 - c1) + r(m1 - c1) – i.e. c2 = m2 + money saved + interest on saved money
=> B.C = c2 = m2 (1 + r) (m1 - c1)
If Consumer Borrows in t1 - what is c2 + the B.C?
Borrows in t1 - c1 > m1
t2: c2 = m2 - (c1 - m1) - r(c1 - m1) – i.e. c2 = m2 - borrowed money - interest on borrowed money
=> B.C = c2 = m2 (1 + r) (m1 - c1)
What is the B.C in terms of Future Value?
(1 + r) c1 + c2 = (1 + r)m1 + m2
- Price of Future Consumption = 1
What is the B.C in terms of Present Value?
c1 + (c2 / 1 + r) = m1 + (m2 / 1 + r)
- Price of Present Consumption = 1
- -> Measures Future Price relative to Present Price
What is the Slope of the B.C?
Slope = - (1 + r)
Where is the Endowment Point?
Middle of B.C- m1 = m2
What does it mean if the Individual is to the Left of the Endowment Point?
They are a LENDER
What does it mean if the Individual is to the Right of the Endowment Point?
They are a BORROWER
