Download presentation

Presentation is loading. Please wait.

Published byMadilyn Shann Modified over 2 years ago

1
Chapter Fourteen Consumer’s Surplus

2
Monetary Measures of Gains-to- Trade Suppose you know you can buy as much gasoline as you choose at a given price of $1 per gallon once you have entered the gasoline market. Q: What is the most you would pay to be able to enter the market for gasoline?

3
A: You would pay a sum up to, but not exceeding, the dollar value to you of the gains-to-trade you would enjoy once inside the market. How can we measure the monetary values of such gains-to-trade? Monetary Measures of Gains-to- Trade

4
We will consider three such measures Consumer’s Surplus Equivalent Variation, and Compensating Variation. Only in one special circumstance do these three measures coincide. Monetary Measures of Gains-to- Trade

5
Suppose gasoline is purchasable only in lumps of one gallon and consider a single consumer. Ask “What is the most she would pay for a 1st gallon?”. Call this r 1, her reservation price for the 1st gallon. r 1 is the dollar equivalent of the marginal utility of the 1st gallon. $ Equivalent Utility Gains

6
Now that she has one gallon, ask “What is the most she would pay for a 2nd gallon?”. Call this r 2, her reservation price for the 2nd gallon. r 2 is the dollar equivalent of the marginal utility of the 2nd gallon. $ Equivalent Utility Gains

7
More generally, if she already has n-1 gallons of gasoline then let r n be the most she will pay for an nth gallon. r n is the dollar equivalent of the marginal utility of the nth gallon. $ Equivalent Utility Gains

8
The sum r 1 + … + r n will therefore be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $0. So r 1 + … + r n - p G n will be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $p G each. $ Equivalent Utility Gains

9
A plot of r 1, r 2, …, r n, … against n is a reservation-price curve. This is not quite the same as the consumer’s demand curve for gasoline. $ Equivalent Utility Gains

10
123456 r1r1 r2r2 r3r3 r4r4 r5r5 r6r6

11
What is the monetary value of our consumer’s gain-to-trading in the gasoline market at a price of $p G ? $ Equivalent Utility Gains

12
For the 1st gallon the dollar equivalent of the net utility gain is $(r 1 - p G ). For the 2nd gallon the dollar equivalent of the net utility gain is $(r 2 - p G ). And so on, so the monetary value of the gain-to-trade is $(r 1 - p G ) + $(r 2 - p G ) + … for as long as r n - p G > 0. $ Equivalent Utility Gains

13
123456 r1r1 r2r2 r3r3 r4r4 r5r5 r6r6 pGpG

14
123456 r1r1 r2r2 r3r3 r4r4 r5r5 r6r6 pGpG $ value of net utility gains-to-trade

15
Now suppose that gasoline is sold in half-gallon units. Now let r 1, r 2, …, r n, … denote the consumer’s reservation prices for successive half-gallons of gasoline. Our consumer’s new reservation price curve is $ Equivalent Utility Gains

16
123456 r1r1 r3r3 r5r5 r7r7 r9r9 r 11 7891011

17
$ Equivalent Utility Gains 123456 r1r1 r3r3 r5r5 r7r7 r9r9 r 11 7891011 pGpG

18
$ Equivalent Utility Gains 123456 r1r1 r3r3 r5r5 r7r7 r9r9 r 11 7891011 pGpG $ value of net utility gains-to-trade

19
Suppose gasoline can be purchased in any quantity. Then our consumer’s reservation price curve is $ Equivalent Utility Gains

20
Gasoline ($) Res. Prices pGpG Reservation Price Curve for Gasoline $ value of net utility gains-to-trade

21
If we approximate the net utility gain area under the reservation-price curve by the corresponding area under the ordinary demand curve then we get the Consumer’s Surplus approximate measure of net utility gain from buying gasoline at a price of $p G. Consumer’s Surplus

22
Consumer’s Surplus is an exact dollar measure of total utility gains from consumption of commodity 1 when the consumer’s utility function is quasilinear in commodity 2. Otherwise Consumer’s Surplus is an approximation. Consumer’s Surplus

23
The change to a consumer’s total utility due to a change to p 1 is approximately measured by the change in her Consumer’s Surplus. Consumer’s Surplus

24
p1p1 For quasi-linear preferences, p 1 (x 1 ) is the inverse ordinary demand curve for commodity 1

25
Consumer’s Surplus p1p1 CS before p 1 (x 1 )

26
Consumer’s Surplus p1p1 CS after p 1 (x 1 )

27
Consumer’s Surplus p1p1 Lost CS p 1 (x 1 ), inverse ordinary demand curve for commodity 1.

28
Two additional monetary measures of the total utility change caused by a price change are Compensating Variation and Equivalent Variation. Compensating Variation and Equivalent Variation

29
Suppose the price of commodity 1 rises. Q: What is the smallest amount of additional income which, at the new prices, would just restore the consumer’s original utility level? A: The Compensating Variation. Compensating Variation

30
x2x2 x1x1 u1u1 p1=p1’p1=p1’p 2 is fixed.

31
Compensating Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed.

32
Compensating Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed.

33
Compensating Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed. CV = m 2 - m 1.

34
Suppose the price of commodity 1 rises. Q: What is the smallest amount of additional income which, at the original prices, would just restore the consumer’s original utility level? A: The Equivalent Variation. Equivalent Variation

35
x2x2 x1x1 u1u1 p1=p1’p1=p1’p 2 is fixed.

36
Equivalent Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed.

37
Equivalent Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed.

38
Equivalent Variation x2x2 x1x1 u1u1 u2u2 p1=p1’p1=p1”p1=p1’p1=p1” p 2 is fixed. EV = m 1 - m 2.

39
What relationships exist between the three monetary measures of utility changes due to price changes? Relationship 1: When the consumer’s preferences are quasilinear, all three measures are the same. Consumer’s Surplus, Compensating Variation and Equivalent Variation

40
Changes in the welfare of a firm can be measured in monetary units in much the same way as for a consumer. Producer’s Surplus

41
y (output units) Output price (p) Marginal Cost

42
Producer’s Surplus y (output units) Output price (p) Marginal Cost Revenue =

43
Producer’s Surplus y (output units) Output price (p) Marginal Cost Variable Cost of producing y’ units is the sum of the marginal costs

44
Producer’s Surplus y (output units) Output price (p) Marginal Cost Variable Cost of producing y’ units is the sum of the marginal costs Revenue less VC is the Producer’s Surplus.

Similar presentations

OK

Chapter Fourteen Consumer’s Surplus. Monetary Measures of Gains-to- Trade You can buy as much gasoline as you wish at $1 per litre once you enter the.

Chapter Fourteen Consumer’s Surplus. Monetary Measures of Gains-to- Trade You can buy as much gasoline as you wish at $1 per litre once you enter the.

© 2017 SlidePlayer.com Inc.

All rights reserved.

Ads by Google

Ppt on search engine optimization Ppt on eye of tiger Ppt on types of business communication Ppt on self development Ppt on statistics for class 11 maths Ppt on social networking and youth Ppt on critical care nursing Ppt on recycling of waste fabric Ppt on bill of exchange for class 11 Ppt on plane table survey