Introduction to Microeconomics (L11100) Section 3: Consumer Welfare and Household as Supplier...
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Transcript of Introduction to Microeconomics (L11100) Section 3: Consumer Welfare and Household as Supplier...
Introduction to Microeconomics (L11100)
Section 3: Consumer Welfare and Household as Supplier
Lectures 8 - 11
Outline
3.1 Compensating and Equivalent Variations in Income (Lecture 8)
3.2 Consumer Surplus (Lecture 9)
3.3 Labour Supply (Lecture 10)
3.4 Dynamic Consumption (Lecture 11)
3.1 Compensating & Equivalent Variations in Income
3.1.1 Defining CV and EV3.1.2 Compensating Variation3.1.3 Equivalent Variation3.1.4 Examples
Application
“Private insurance subsidy has increased stress on public health system” BMJ News Extra 28th February 2004
•Attempt to get Australians to move away from national health care to private
•Subsidised private premiums by 30% (1999)
•Anyone signing up before age of 30 got lowest premium for life
•What impact did it have? Increased take-up of private health care but drew resources from the national health sector too
3.1 Defining CV and EV
Price changes leads to welfare changes i.e. as P rises, W falls and vice versa. Need to measure this not in utils but in monetary terms.
Compensating Variation - amount of nominal income by which an individual would need to be compensated for a price change to remain at his/her initial utility level
Equivalent Variation - change in nominal income that is equivalent in its effect on utility to a change in the price of a commodity
Real Income - the bundle of goods and services that can be bought. Along an indifference curve, real income is constant
Compensating Variation
Compensates the consumer for a fall in real income as prices rise (or vice versa)
Graphically, the technique we have used so far
The new budget constraint is pulled back (parallel) to the original indifference curve
3.1.2 Compensating Variation
Income or All Other Goods
QABC21
BA
BC32
U1
U2
BC1
3
C
CVCompensating Variation
NEW price ratio
OLD indifference-curve
Equivalent Variation
The amount by which nominal income would have to change to be equivalent to the effect of the price change
Graphically, a new technique
The old budget constraint is moved (parallel) to the new indifference curve
3.1.3 Equivalent Variation
Income or All Other Goods
QA
U1
U2
BC1
BC22 3 1
BA
C
BC3
EV
Equivalent Variation
OLD price ratio
NEW indifference curve
Is a subsidised price for housing the same as a payment to homebuyers?
Income or All Other Goods
Sq. Ms of HousingBC1
A
B
BC3
U1
U2
BC2
C
EV
Cost of subsidy
Pensioners: fuel gifts or cash payments to keep them warm?
Income or All Other Goods
Fuel Consumption
BC2
BA
U1
U3
BC1
Fuel Gift
CU2