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
What is the Present Value of Endowment?
m1 + (m2 / 1 + r)
What is the Future Value of Endowment?
(1 + r) m1 + m2
What does I.C indicate for Intertemporal Choice?
Consumer’s Tastes for Consumption at Different Times
What does it mean if Slope of I.C is a Constant Slope = 1?
- Consumer does NOT care if they Consume Today or Tomorrow
- I.Cs are Straight Lines
- MRS between Today + Tomorrow = -1
What does it mean if I.C is L-Shaped?
Perfect Complements - Equal Consumption Today + Tomorrow
- Unwilling to Sub. Consumption between Periods
What does it mean for Well-Behaved Preferences for Intertemporal Choice?
Consumer is Willing to Sub. some Consumption for Future Consumption
What does it mean for Convexity of Preferences for Intertemporal Choice?
Consumer would like ‘Average’ Consumption in each Period rather than A lot in One Period + None in Next Period
What does the Effect of a Change in I.R depend on?
Depends on whether Consumer is Initially a LENDER or BORROWER
What is the effect of Increased I.R if Consumer is Initially a LENDER?
c1 < m1 Increased I.R --> STEEPER B.C - For given Reduction in c1 --> Consumer gets More Consumption in t2 => New Optimal Consumption = c'1 < m1 - Consumer REMAINS a LENDER Moves Up Budget Line
What is the effect of Decreased I.R if Consumer is Initially a BORROWER?
c1 > m1 Decreased I.R --> FLATTER B.C - For given Reduction in c1 --> Consumer gets Less Consumption in t2 => New Optimal Consumption = c'1 > m1 - Consumer REMAINS a BORROWER Moves Down Budget Line
What is the effect of Decreased I.R if Consumer is Initially a LENDER?
Lender –> Decreased I.R –> May switch to being a BORROWER
What is the effect of Increased I.R if Consumer is Initially a BORROWER?
Borrower –> Increased I.R –> May switch to being a LENDER
What does the Slutsky Equation do?
Decomposes Change in Demand (due to Change in I.R) into Income + Sub. Effects
What is Effect on Consumption in each Period from Increased I.R?
Use Future Value B.C
- Increased I.R - means Today is Relatively More Expensive compared to Future Consumption
What is the Slutsky Equation?
dc1 / dp1 = (dc1s / dp1) + (m1 - c1) (dc1m / dm)
What is the SE?
SE is Negative: (dc1s / dp1) < 0
What is IE if Consumption in t1 is Normal?
IE is Positive: (dc1m / dm) > 0
What does the sign of TE depend on?
TE: dc1 / dp1 - depends on Sign of (m1 - c1)
What is the Slutsky Effect if Consumer is a Borrower?
c1 > m1 –> dc1 / dp1 < 0
Increased I.R - Consumer Subs. away from Current Consump.
- It becomes relatively more expensive
What is the Slutsky Effect if Consumer is a Lender?
c1 < m1 –> Effect is Ambiguous
Increased I.R - May give Consumer enough Extra Income to want to Consume even more in t1
What is the Effect of Imperfect Capital Markets?
When Borrowing- I.R Higher than when Saving
How do Imperfect Capital Markets affect the B.C?
Slope of B.C- Greater to Right of Endowment Point + Smaller to Left of Endowment Point
- Kink in B.C at Initial Endowment Point
Both c2 + c1 are Lower than Perfect Capital Markets
