SlideShare a Scribd company logo
Chapter Fourteen
Consumer’s Surplus
Monetary Measures of Gains-toTrade
 You

can buy as much gasoline as
you wish at $1 per gallon once you
enter the gasoline market.
 Q: What is the most you would pay
to enter the market?
Monetary Measures of Gains-toTrade
 A:

You would pay up to the dollar
value of the gains-to-trade you would
enjoy once in the market.
 How can such gains-to-trade be
measured?
Monetary Measures of Gains-toTrade
 Three

such measures are:
Consumer’s Surplus
Equivalent Variation, and
Compensating Variation.
 Only in one special circumstance do
these three measures coincide.
$ Equivalent Utility Gains
 Suppose

gasoline can be bought
only in lumps of one gallon.
 Use r1 to denote the most a single
consumer would pay for a 1st gallon
-- call this her reservation price for
the 1st gallon.
 r1 is the dollar equivalent of the
marginal utility of the 1st gallon.
$ Equivalent Utility Gains
 Now

that she has one gallon, use r2
to denote the most she would pay for
a 2nd gallon -- this is her reservation
price for the 2nd gallon.
 r2 is the dollar equivalent of the
marginal utility of the 2nd gallon.
$ Equivalent Utility Gains
 Generally,

if she already has n-1
gallons of gasoline then rn denotes
the most she will pay for an nth
gallon.
 rn is the dollar equivalent of the
marginal utility of the nth gallon.
$ Equivalent Utility Gains
 r1

+ … + rn will therefore be the dollar
equivalent of the total change to
utility from acquiring n gallons of
gasoline at a price of $0.
 So r1 + … + rn - pGn will be the dollar
equivalent of the total change to
utility from acquiring n gallons of
gasoline at a price of $pG each.
$ Equivalent Utility Gains
A

plot of r1, r2, … , rn, … against n is a
reservation-price curve. This is not
quite the same as the consumer’s
demand curve for gasoline.
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

10
r1
8
r2
6
r3
4
r4
2
r5
0
r6

1

2

3

4

5

Gasoline (gallons)

6
$ Equivalent Utility Gains
 What

is the monetary value of our
consumer’s gain-to-trading in the
gasoline market at a price of $pG?
$ Equivalent Utility Gains
 The

dollar equivalent net utility gain for
the 1st gallon is $(r1 - pG)

 and
 and

is $(r2 - pG) for the 2nd gallon,

so on, so the dollar value of the
gain-to-trade is
$(r1 - pG) + $(r2 - pG) + …
for as long as rn - pG > 0.
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

10
r1
8
r2
6
r3
4
r4
2
r5
0
r6

pG
1

2

3

4

5

Gasoline (gallons)

6
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

10
r1
8
r2
6
r3
4
r4
2
r5
0
r6

pG
1

2

3

4

5

Gasoline (gallons)

6
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

$ value of net utility gains-to-trade

10
r1
8
r2
6
r3
4
r4
2
r5
0
r6

pG
1

2

3

4

5

Gasoline (gallons)

6
$ Equivalent Utility Gains
 Now

suppose that gasoline is sold in
half-gallon units.
 r1, r2, … , rn, … denote the consumer’s
reservation prices for successive
half-gallons of gasoline.
 Our consumer’s new reservation
price curve is
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

10
r1
8
r3
6
r5
4
r7
2
r9
0
r11

1 2 3 4 5 6 7 8 9 10 11
Gasoline (half gallons)
$ Equivalent Utility Gains
($) Res.
Values

Reservation Price Curve for Gasoline

10
r1
8
r3
6
r5
4
r7
2
r9
0
r11

pG
1 2 3 4 5 6 7 8 9 10 11
Gasoline (half gallons)
$ Equivalent Utility Gains
($) Res.
Values
10
r1
8
r3
6
r5
4
r7
2
r9
0
r11

Reservation Price Curve for Gasoline

$ value of net utility gains-to-trade

pG
1 2 3 4 5 6 7 8 9 10 11
Gasoline (half gallons)
$ Equivalent Utility Gains
 And

if gasoline is available in onequarter gallon units ...
$ Equivalent Utility Gains
Reservation Price Curve for Gasoline
10
8
($) Res.
6
Values
4
2
0

1 2 3 4 5 6 7 8 9 10 11
Gasoline (one-quarter gallons)
$ Equivalent Utility Gains
Reservation Price Curve for Gasoline
10
8
($) Res.
6
Values
4

pG

2
0

1 2 3 4 5 6 7 8 9 10 11
Gasoline (one-quarter gallons)
$ Equivalent Utility Gains
Reservation Price Curve for Gasoline
10

$ value of net utility gains-to-trade

8
($) Res.
6
Values
4

pG

2
0
Gasoline (one-quarter gallons)
$ Equivalent Utility Gains
 Finally,

if gasoline can be purchased
in any quantity then ...
$ Equivalent Utility Gains
($) Res.
Prices

Reservation Price Curve for Gasoline

Gasoline
$ Equivalent Utility Gains
($) Res.
Prices

Reservation Price Curve for Gasoline

pG

Gasoline
$ Equivalent Utility Gains
($) Res.
Prices

Reservation Price Curve for Gasoline
$ value of net utility gains-to-trade

pG

Gasoline
$ Equivalent Utility Gains
 Unfortunately,

estimating a
consumer’s reservation-price curve
is difficult,
 so, as an approximation, the
reservation-price curve is replaced
with the consumer’s ordinary
demand curve.
Consumer’s Surplus
A

consumer’s reservation-price
curve is not quite the same as her
ordinary demand curve. Why not?
 A reservation-price curve describes
sequentially the values of
successive single units of a
commodity.
 An ordinary demand curve describes
the most that would be paid for q
units of a commodity purchased
simultaneously.
Consumer’s Surplus
 Approximating

the net utility gain
area under the reservation-price
curve by the corresponding area
under the ordinary demand curve
gives the Consumer’s Surplus
measure of net utility gain.
Consumer’s Surplus
($) Reservation price curve for gasoline
Ordinary demand curve for gasoline

Gasoline
Consumer’s Surplus
($) Reservation price curve for gasoline
Ordinary demand curve for gasoline

pG

Gasoline
Consumer’s Surplus
($) Reservation price curve for gasoline
Ordinary demand curve for gasoline
$ value of net utility gains-to-trade

pG

Gasoline
Consumer’s Surplus
($) Reservation price curve for gasoline
Ordinary demand curve for gasoline
$ value of net utility gains-to-trade
Consumer’s Surplus
pG

Gasoline
Consumer’s Surplus
($) Reservation price curve for gasoline
Ordinary demand curve for gasoline
$ value of net utility gains-to-trade
Consumer’s Surplus
pG

Gasoline
Consumer’s Surplus
 The

difference between the
consumer’s reservation-price and
ordinary demand curves is due to
income effects.
 But, if the consumer’s utility function
is quasilinear in income then there
are no income effects and
Consumer’s Surplus is an exact $
measure of gains-to-trade.
Consumer’s Surplus
The consumer’s utility function is
quasilinear in x2.

U( x1 , x 2 ) = v( x1 ) + x 2
Take p2 = 1. Then the consumer’s
choice problem is to maximize

U( x1 , x 2 ) = v( x1 ) + x 2

subject to

p1x1 + x 2 = m.
Consumer’s Surplus
The consumer’s utility function is
quasilinear in x2.

U( x1 , x 2 ) = v( x1 ) + x 2
Take p2 = 1. Then the consumer’s
choice problem is to maximize

U( x1 , x 2 ) = v( x1 ) + x 2

subject to

p1x1 + x 2 = m.
Consumer’s Surplus
That is, choose x1 to maximize

v( x1 ) + m − p1x1 .
The first-order condition is

v'( x1 ) − p1 = 0
That is,

p1 = v'( x1 ).

This is the equation of the consumer’s
ordinary demand for commodity 1.
Consumer’s Surplus
p1

Ordinary demand curve, p1 = v'( x1 )

CS
p'
1
x'
1

x*
1
Consumer’s Surplus
p1

Ordinary demand curve, p1 = v'( x1 )
x' v'( x ) dx − p' x'
CS = ∫0 1
1
1
1 1

CS
p'
1
x'
1

x*
1
Consumer’s Surplus
p1

Ordinary demand curve, p1 = v'( x1 )
x' v'( x ) dx − p' x'
CS = ∫0 1
1
1
1 1
= v( x' ) − v( 0 ) − p' x'
1
1 1

CS
p'
1
x'
1

x*
1
Consumer’s Surplus
p1

p'
1

Ordinary demand curve, p1 = v'( x1 )
x' v'( x ) dx − p' x'
CS = ∫0 1
1
1
1 1
= v( x' ) − v( 0 ) − p' x'
1
1 1
is exactly the consumer’s utility
CS
gain from consuming x1’
units of commodity 1.
x'
1

x*
1
Consumer’s Surplus
 Consumer’s

Surplus is an exact
dollar measure of utility gained from
consuming commodity 1 when the
consumer’s utility function is
quasilinear in commodity 2.
 Otherwise Consumer’s Surplus is an
approximation.
Consumer’s Surplus
 The

change to a consumer’s total
utility due to a change to p1 is
approximately the change in her
Consumer’s Surplus.
Consumer’s Surplus
p1
p1(x1), the inverse ordinary demand
curve for commodity 1

p'
1
x'
1

x*
1
Consumer’s Surplus
p1
p1(x1)

p'
1

CS before
x'
1

x*
1
Consumer’s Surplus
p1
p1(x1)
p" CS after
1

p'
1
x"
1

x'
1

x*
1
Consumer’s Surplus
p1
p1(x1), inverse ordinary demand
curve for commodity 1.
p"
1

p'
1

Lost CS

x"
1

x'
1

x*
1
x*
1

Consumer’s Surplus

x'
1

x1*(p1), the consumer’s ordinary
demand curve for commodity 1.
"
p1
'
p1

∆CS = ∫
x"
1

Lost
CS
p'
1

p"
1

*
x1(p1)dp1

measures the loss in
Consumer’s Surplus.

p1
Compensating Variation and
Equivalent Variation
 Two

additional dollar measures of
the total utility change caused by a
price change are Compensating
Variation and Equivalent Variation.
Compensating Variation
 p1

rises.

 Q:

What is the least extra income
that, at the new prices, just restores
the consumer’s original utility level?
Compensating Variation
 p1

rises.

 Q:

What is the least extra income
that, at the new prices, just restores
the consumer’s original utility level?
 A: The Compensating Variation.
Compensating Variation
x2

p1=p1’

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

x'2

u1
x'
1

x1
Compensating Variation
p1=p1’
p1=p1”

x2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2
x'2

u1
u2
x"
1

x'
1

x1
Compensating Variation
p1=p1’
p1=p1”

x2
x'"
2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2

" '"
m2 = p1x1

x'2

u1
u2
x" x'"
1
1

x'
1

x1

'"
+ p2 x 2
Compensating Variation
p1=p1’
p1=p1”

x2
x'"
2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2

" '"
m2 = p1x1

x'2

'"
+ p2 x 2

u1
u2
x" x'"
1
1

x'
1

CV = m2 - m1.
x1
Equivalent Variation
 p1

rises.

 Q:

What is the least extra income
that, at the original prices, just
restores the consumer’s original
utility level?
 A: The Equivalent Variation.
Equivalent Variation
x2

p1=p1’

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

x'2

u1
x'
1

x1
Equivalent Variation
p1=p1’
p1=p1”

x2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2
x'2

u1
u2
x"
1

x'
1

x1
Equivalent Variation
p1=p1’
p1=p1”

x2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2

m2 = p' x'" + p 2x'"
1 1
2

x'2
x'"
2

u1
u2
x"
1

x'" x'
1
1

x1
Equivalent Variation
p1=p1’
p1=p1”

x2

p2 is fixed.
m1 = p' x' + p 2x'2
1 1

= p"x" + p 2x"
1 1
2

x"
2

m2 = p' x'" + p 2x'"
1 1
2

x'2
x'"
2

u1
u2
x"
1

x'" x'
1
1

EV = m1 - m2.
x1
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
 Relationship

1: When the
consumer’s preferences are
quasilinear, all three measures are
the same.
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
 Consider

first the change in
Consumer’s Surplus when p1 rises
from p1’ to p1”.
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
If

U( x1 , x 2 ) = v( x1 ) + x 2

then

'
'
' '
CS( p1 ) = v( x1 ) − v( 0 ) − p1x1
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
If

U( x1 , x 2 ) = v( x1 ) + x 2

then

'
'
' '
CS( p1 ) = v( x1 ) − v( 0 ) − p1x1

and so the change in CS when p1 rises
from p1’ to p1” is
'
"
∆CS = CS( p1 ) − CS( p1 )
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
If

U( x1 , x 2 ) = v( x1 ) + x 2

then

'
'
' '
CS( p1 ) = v( x1 ) − v( 0 ) − p1x1

and so the change in CS when p1 rises
from p1’ to p1” is
'
"
∆CS = CS( p1 ) − CS( p1 )

[

= v( x' ) − v( 0 ) − p' x' − v( x" ) − v( 0 ) − p"x"
1
1 1
1
1 1

]
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
If

U( x1 , x 2 ) = v( x1 ) + x 2

then

'
'
' '
CS( p1 ) = v( x1 ) − v( 0 ) − p1x1

and so the change in CS when p1 rises
from p1’ to p1” is
'
"
∆CS = CS( p1 ) − CS( p1 )

[

= v( x' ) − v( 0 ) − p' x' − v( x" ) − v( 0 ) − p"x"
1
1 1
1
1 1
= v( x' ) − v( x" ) − ( p' x' − p"x" ).
1
1
1 1
1 1

]
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
 Now

consider the change in CV when
p1 rises from p1’ to p1”.

 The

consumer’s utility for given p 1 is
*
*
v( x1 ( p1 )) + m − p1x1 ( p1 )

and CV is the extra income which, at
the new prices, makes the
consumer’s utility the same as at the
old prices. That is, ...
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
'
' '
v( x1 ) + m − p1x1
"
" "
= v( x1 ) + m + CV − p1x1 .
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
'
' '
v( x1 ) + m − p1x1
"
" "
= v( x1 ) + m + CV − p1x1 .
So
'
"
' '
" "
CV = v( x1 ) − v( x1 ) − ( p1x1 − p1x1 )

= ∆CS.
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
 Now

consider the change in EV when
p1 rises from p1’ to p1”.

 The

consumer’s utility for given p 1 is
*
*
v( x1 ( p1 )) + m − p1x1 ( p1 )

and EV is the extra income which, at
the old prices, makes the consumer’s
utility the same as at the new prices.
That is, ...
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
'
' '
v( x1 ) + m − p1x1
"
" "
= v( x1 ) + m + EV − p1x1 .
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
'
' '
v( x1 ) + m − p1x1
"
" "
= v( x1 ) + m + EV − p1x1 .
That is,
EV = v( x' ) − v( x" ) − ( p' x' − p"x" )
1
1
1 1
1 1

= ∆CS.
Consumer’s Surplus, Compensating
Variation and Equivalent Variation
So when the consumer has quasilinear
utility,
CV = EV = ∆CS.
But, otherwise, we have:
Relationship 2: In size, EV < ∆CS < CV.
Producer’s Surplus
 Changes

in a firm’s welfare can be
measured in dollars much as for a
consumer.
Producer’s Surplus
Output price (p)
Marginal Cost

y (output units)
Producer’s Surplus
Output price (p)
Marginal Cost
p'

y'

y (output units)
Producer’s Surplus
Output price (p)
Marginal Cost
p'

Revenue
p'y'
=
y'

y (output units)
Producer’s Surplus
Output price (p)
Marginal Cost
p'

Variable Cost of producing
y’ units is the sum of the
marginal costs
y'

y (output units)
Producer’s Surplus
Output price (p)
Revenue less VC
is the Producer’s
Surplus.
p'

Marginal Cost

Variable Cost of producing
y’ units is the sum of the
marginal costs
y'

y (output units)

More Related Content

What's hot

Micro_ch21_presentation.ppt
Micro_ch21_presentation.pptMicro_ch21_presentation.ppt
Micro_ch21_presentation.ppt
nisaandini13
 
Lecture7
Lecture7Lecture7
Lecture7
Awais Idrees
 
Microeconomics: Income and Substitution Effects
Microeconomics: Income and Substitution EffectsMicroeconomics: Income and Substitution Effects
Microeconomics: Income and Substitution Effects
Manuel Salas-Velasco, University of Granada, Spain
 
Budget constrain
Budget constrainBudget constrain
Budget constrain
Binayak Pandit
 
cobb douglas production function
cobb douglas production functioncobb douglas production function
cobb douglas production function
Lakshmanamoorthi Moorthi
 
Indifference curve analysis ordinal utility approach
Indifference curve analysis   ordinal utility approachIndifference curve analysis   ordinal utility approach
Indifference curve analysis ordinal utility approach
vipul gangwar
 
Economics c03l03-gdp
Economics c03l03-gdpEconomics c03l03-gdp
Economics c03l03-gdp
MBA @ Faculty of Entrepreneurship
 
MACROECONOMICS-CH5
MACROECONOMICS-CH5MACROECONOMICS-CH5
MACROECONOMICS-CH5
kkjjkevin03
 
Krugman ch 2 ppt
Krugman ch 2 pptKrugman ch 2 ppt
Krugman ch 2 ppt
dhohnhol
 
Theory Of Consumer Behavior
Theory Of Consumer BehaviorTheory Of Consumer Behavior
Theory Of Consumer Behavior
Kishore Raveendran
 
Demand analysis
Demand analysis Demand analysis
Demand analysis
Federation of Consumers
 
Elasticity of demand
Elasticity of demandElasticity of demand
Elasticity of demand
Jithin Thomas
 
Keynesian model with multiplier
Keynesian model with multiplierKeynesian model with multiplier
Keynesian model with multiplier
Michael Noel
 
7 utility
7 utility7 utility
7 utility
gannibhai
 
Unit 2 3 2 Perfect Competition
Unit 2 3 2 Perfect CompetitionUnit 2 3 2 Perfect Competition
Unit 2 3 2 Perfect Competition
Corey Topf
 
Bilateral monopoly
Bilateral monopolyBilateral monopoly
Bilateral monopoly
MuhammedSuhaibM
 
Ch20
Ch20Ch20
Ch20
waiwai28
 
cardinal theory
cardinal theorycardinal theory
cardinal theory
Naveen Sharma
 
Addendum to lecture 4 okun's law
Addendum to lecture 4 okun's lawAddendum to lecture 4 okun's law
Addendum to lecture 4 okun's law
Richard Wills
 
Consumer behaviour and utility analysis
Consumer behaviour and utility analysisConsumer behaviour and utility analysis
Consumer behaviour and utility analysis
Dr. Shweta Uppadhyay
 

What's hot (20)

Micro_ch21_presentation.ppt
Micro_ch21_presentation.pptMicro_ch21_presentation.ppt
Micro_ch21_presentation.ppt
 
Lecture7
Lecture7Lecture7
Lecture7
 
Microeconomics: Income and Substitution Effects
Microeconomics: Income and Substitution EffectsMicroeconomics: Income and Substitution Effects
Microeconomics: Income and Substitution Effects
 
Budget constrain
Budget constrainBudget constrain
Budget constrain
 
cobb douglas production function
cobb douglas production functioncobb douglas production function
cobb douglas production function
 
Indifference curve analysis ordinal utility approach
Indifference curve analysis   ordinal utility approachIndifference curve analysis   ordinal utility approach
Indifference curve analysis ordinal utility approach
 
Economics c03l03-gdp
Economics c03l03-gdpEconomics c03l03-gdp
Economics c03l03-gdp
 
MACROECONOMICS-CH5
MACROECONOMICS-CH5MACROECONOMICS-CH5
MACROECONOMICS-CH5
 
Krugman ch 2 ppt
Krugman ch 2 pptKrugman ch 2 ppt
Krugman ch 2 ppt
 
Theory Of Consumer Behavior
Theory Of Consumer BehaviorTheory Of Consumer Behavior
Theory Of Consumer Behavior
 
Demand analysis
Demand analysis Demand analysis
Demand analysis
 
Elasticity of demand
Elasticity of demandElasticity of demand
Elasticity of demand
 
Keynesian model with multiplier
Keynesian model with multiplierKeynesian model with multiplier
Keynesian model with multiplier
 
7 utility
7 utility7 utility
7 utility
 
Unit 2 3 2 Perfect Competition
Unit 2 3 2 Perfect CompetitionUnit 2 3 2 Perfect Competition
Unit 2 3 2 Perfect Competition
 
Bilateral monopoly
Bilateral monopolyBilateral monopoly
Bilateral monopoly
 
Ch20
Ch20Ch20
Ch20
 
cardinal theory
cardinal theorycardinal theory
cardinal theory
 
Addendum to lecture 4 okun's law
Addendum to lecture 4 okun's lawAddendum to lecture 4 okun's law
Addendum to lecture 4 okun's law
 
Consumer behaviour and utility analysis
Consumer behaviour and utility analysisConsumer behaviour and utility analysis
Consumer behaviour and utility analysis
 

Similar to Ch14

Demand and supply concept
Demand and supply conceptDemand and supply concept
Demand and supply concept
Annapurna Sinha
 
Elasticity of Demand and Supply (longer edition)
Elasticity of Demand and Supply (longer edition)Elasticity of Demand and Supply (longer edition)
Elasticity of Demand and Supply (longer edition)
Gene Hayward
 
Lecture3(ch5)
Lecture3(ch5)Lecture3(ch5)
Lecture3(ch5)
hiraaal
 
Demand Notes
Demand NotesDemand Notes
Demand Notes
bscritch
 
Ch. 3-demand-theory
Ch. 3-demand-theoryCh. 3-demand-theory
Ch. 3-demand-theory
anj134u
 
Monopoly
MonopolyMonopoly
Monopoly
Gene Hayward
 
Lecture 5 elasticity
Lecture 5 elasticityLecture 5 elasticity
Lecture 5 elasticity
MR.TAIYEB FARUQUEI
 
5 monopoly
5 monopoly5 monopoly
5 monopoly
Rajesh Neithilath
 
Micro 14
Micro 14Micro 14
Micro 14
Gale Pooley
 
Theory of consumer behavior
Theory of consumer behaviorTheory of consumer behavior
Theory of consumer behavior
er_kamal
 
a. elasticity of demand
 a. elasticity of demand a. elasticity of demand
a. elasticity of demand
Raunak Khinwasra
 
marketefficiency.pdf
marketefficiency.pdfmarketefficiency.pdf
marketefficiency.pdf
nizzami
 
Market efficiency 2022.ppt
Market efficiency 2022.pptMarket efficiency 2022.ppt
Market efficiency 2022.ppt
Jon Newland
 
Fin415 Week 4 Slides
Fin415 Week 4 SlidesFin415 Week 4 Slides
Fin415 Week 4 Slides
smarkbarnes
 
2 demand-supply and elasticity
2  demand-supply and elasticity2  demand-supply and elasticity
2 demand-supply and elasticity
dannygriff1
 
Micro 15
Micro 15Micro 15
Micro 15
Gale Pooley
 
Ch 2 supply demand and elasticity-2.2.ppt
Ch 2 supply demand and elasticity-2.2.pptCh 2 supply demand and elasticity-2.2.ppt
Ch 2 supply demand and elasticity-2.2.ppt
Ergin Akalpler
 
Consumer producer surplus
Consumer producer surplusConsumer producer surplus
Consumer producer surplus
jorr719
 
Agri 2312 chapter 8 market equilibrium and product price
Agri 2312 chapter 8 market equilibrium and product priceAgri 2312 chapter 8 market equilibrium and product price
Agri 2312 chapter 8 market equilibrium and product price
Rita Conley
 
Economics
EconomicsEconomics
Economics
Malavige Romesha
 

Similar to Ch14 (20)

Demand and supply concept
Demand and supply conceptDemand and supply concept
Demand and supply concept
 
Elasticity of Demand and Supply (longer edition)
Elasticity of Demand and Supply (longer edition)Elasticity of Demand and Supply (longer edition)
Elasticity of Demand and Supply (longer edition)
 
Lecture3(ch5)
Lecture3(ch5)Lecture3(ch5)
Lecture3(ch5)
 
Demand Notes
Demand NotesDemand Notes
Demand Notes
 
Ch. 3-demand-theory
Ch. 3-demand-theoryCh. 3-demand-theory
Ch. 3-demand-theory
 
Monopoly
MonopolyMonopoly
Monopoly
 
Lecture 5 elasticity
Lecture 5 elasticityLecture 5 elasticity
Lecture 5 elasticity
 
5 monopoly
5 monopoly5 monopoly
5 monopoly
 
Micro 14
Micro 14Micro 14
Micro 14
 
Theory of consumer behavior
Theory of consumer behaviorTheory of consumer behavior
Theory of consumer behavior
 
a. elasticity of demand
 a. elasticity of demand a. elasticity of demand
a. elasticity of demand
 
marketefficiency.pdf
marketefficiency.pdfmarketefficiency.pdf
marketefficiency.pdf
 
Market efficiency 2022.ppt
Market efficiency 2022.pptMarket efficiency 2022.ppt
Market efficiency 2022.ppt
 
Fin415 Week 4 Slides
Fin415 Week 4 SlidesFin415 Week 4 Slides
Fin415 Week 4 Slides
 
2 demand-supply and elasticity
2  demand-supply and elasticity2  demand-supply and elasticity
2 demand-supply and elasticity
 
Micro 15
Micro 15Micro 15
Micro 15
 
Ch 2 supply demand and elasticity-2.2.ppt
Ch 2 supply demand and elasticity-2.2.pptCh 2 supply demand and elasticity-2.2.ppt
Ch 2 supply demand and elasticity-2.2.ppt
 
Consumer producer surplus
Consumer producer surplusConsumer producer surplus
Consumer producer surplus
 
Agri 2312 chapter 8 market equilibrium and product price
Agri 2312 chapter 8 market equilibrium and product priceAgri 2312 chapter 8 market equilibrium and product price
Agri 2312 chapter 8 market equilibrium and product price
 
Economics
EconomicsEconomics
Economics
 

More from Jan Novak

Ch25
Ch25Ch25
Ch25
Jan Novak
 
Ch24
Ch24Ch24
Ch24
Jan Novak
 
Ch23
Ch23Ch23
Ch23
Jan Novak
 
Ch21
Ch21Ch21
Ch21
Jan Novak
 
Ch20
Ch20Ch20
Ch20
Jan Novak
 
Ch19
Ch19Ch19
Ch19
Jan Novak
 
Ch18
Ch18Ch18
Ch18
Jan Novak
 
Ch17
Ch17Ch17
Ch17
Jan Novak
 
Ch16
Ch16Ch16
Ch16
Jan Novak
 
Ch15
Ch15Ch15
Ch15
Jan Novak
 
Ch13
Ch13Ch13
Ch13
Jan Novak
 
Ch12
Ch12Ch12
Ch12
Jan Novak
 
Ch11
Ch11Ch11
Ch11
Jan Novak
 
Ch7
Ch7Ch7
Ch6
Ch6Ch6
Ch5
Ch5Ch5
Ch4
Ch4Ch4
Ch3
Ch3Ch3
Ch2
Ch2Ch2
Ch1
Ch1Ch1

More from Jan Novak (20)

Ch25
Ch25Ch25
Ch25
 
Ch24
Ch24Ch24
Ch24
 
Ch23
Ch23Ch23
Ch23
 
Ch21
Ch21Ch21
Ch21
 
Ch20
Ch20Ch20
Ch20
 
Ch19
Ch19Ch19
Ch19
 
Ch18
Ch18Ch18
Ch18
 
Ch17
Ch17Ch17
Ch17
 
Ch16
Ch16Ch16
Ch16
 
Ch15
Ch15Ch15
Ch15
 
Ch13
Ch13Ch13
Ch13
 
Ch12
Ch12Ch12
Ch12
 
Ch11
Ch11Ch11
Ch11
 
Ch7
Ch7Ch7
Ch7
 
Ch6
Ch6Ch6
Ch6
 
Ch5
Ch5Ch5
Ch5
 
Ch4
Ch4Ch4
Ch4
 
Ch3
Ch3Ch3
Ch3
 
Ch2
Ch2Ch2
Ch2
 
Ch1
Ch1Ch1
Ch1
 

Recently uploaded

Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
National Information Standards Organization (NISO)
 
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
MANIVALANSR
 
View Inheritance in Odoo 17 - Odoo 17 Slides
View Inheritance in Odoo 17 - Odoo 17  SlidesView Inheritance in Odoo 17 - Odoo 17  Slides
View Inheritance in Odoo 17 - Odoo 17 Slides
Celine George
 
MVC Interview Questions PDF By ScholarHat
MVC Interview Questions PDF By ScholarHatMVC Interview Questions PDF By ScholarHat
MVC Interview Questions PDF By ScholarHat
Scholarhat
 
The Cruelty of Animal Testing in the Industry.pdf
The Cruelty of Animal Testing in the Industry.pdfThe Cruelty of Animal Testing in the Industry.pdf
The Cruelty of Animal Testing in the Industry.pdf
luzmilaglez334
 
Imagination in Computer Science Research
Imagination in Computer Science ResearchImagination in Computer Science Research
Imagination in Computer Science Research
Abhik Roychoudhury
 
QCE – Unpacking the syllabus Implications for Senior School practices and ass...
QCE – Unpacking the syllabus Implications for Senior School practices and ass...QCE – Unpacking the syllabus Implications for Senior School practices and ass...
QCE – Unpacking the syllabus Implications for Senior School practices and ass...
mansk2
 
ASP.NET Core Interview Questions PDF By ScholarHat.pdf
ASP.NET Core Interview Questions PDF By ScholarHat.pdfASP.NET Core Interview Questions PDF By ScholarHat.pdf
ASP.NET Core Interview Questions PDF By ScholarHat.pdf
Scholarhat
 
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
Codeavour International
 
A beginner’s guide to project reviews - everything you wanted to know but wer...
A beginner’s guide to project reviews - everything you wanted to know but wer...A beginner’s guide to project reviews - everything you wanted to know but wer...
A beginner’s guide to project reviews - everything you wanted to know but wer...
Association for Project Management
 
MathematicsGrade7-Presentation-July-12024.pptx
MathematicsGrade7-Presentation-July-12024.pptxMathematicsGrade7-Presentation-July-12024.pptx
MathematicsGrade7-Presentation-July-12024.pptx
nolicaliso1
 
11. Post harvest quality, Quality criteria and Judgement.pptx
11. Post harvest quality, Quality criteria and Judgement.pptx11. Post harvest quality, Quality criteria and Judgement.pptx
11. Post harvest quality, Quality criteria and Judgement.pptx
UmeshTimilsina1
 
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
Dr. Nasir Mustafa
 
How to Manage Line Discount in Odoo 17 POS
How to Manage Line Discount in Odoo 17 POSHow to Manage Line Discount in Odoo 17 POS
How to Manage Line Discount in Odoo 17 POS
Celine George
 
Our Guide to the July 2024 USPS® Rate Change
Our Guide to the July 2024 USPS® Rate ChangeOur Guide to the July 2024 USPS® Rate Change
Our Guide to the July 2024 USPS® Rate Change
Postal Advocate Inc.
 
Introduction to Google Productivity Tools for Office and Personal Use
Introduction to Google Productivity Tools for Office and Personal UseIntroduction to Google Productivity Tools for Office and Personal Use
Introduction to Google Productivity Tools for Office and Personal Use
Excellence Foundation for South Sudan
 
Introduction to Banking System in India.ppt
Introduction to Banking System in India.pptIntroduction to Banking System in India.ppt
Introduction to Banking System in India.ppt
Dr. S. Bulomine Regi
 
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
Nguyen Thanh Tu Collection
 
Parkinson Disease & Anti-Parkinsonian Drugs.pptx
Parkinson Disease & Anti-Parkinsonian Drugs.pptxParkinson Disease & Anti-Parkinsonian Drugs.pptx
Parkinson Disease & Anti-Parkinsonian Drugs.pptx
AnujVishwakarma34
 
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptxSD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
elwoodprias1
 

Recently uploaded (20)

Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
Lange and Roberts "DEIA in the Scholarly Landscape Session 5: DEIA in Peer Re...
 
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
slidesgo-mastering-the-art-of-listening-insights-from-robin-sharma-2024070718...
 
View Inheritance in Odoo 17 - Odoo 17 Slides
View Inheritance in Odoo 17 - Odoo 17  SlidesView Inheritance in Odoo 17 - Odoo 17  Slides
View Inheritance in Odoo 17 - Odoo 17 Slides
 
MVC Interview Questions PDF By ScholarHat
MVC Interview Questions PDF By ScholarHatMVC Interview Questions PDF By ScholarHat
MVC Interview Questions PDF By ScholarHat
 
The Cruelty of Animal Testing in the Industry.pdf
The Cruelty of Animal Testing in the Industry.pdfThe Cruelty of Animal Testing in the Industry.pdf
The Cruelty of Animal Testing in the Industry.pdf
 
Imagination in Computer Science Research
Imagination in Computer Science ResearchImagination in Computer Science Research
Imagination in Computer Science Research
 
QCE – Unpacking the syllabus Implications for Senior School practices and ass...
QCE – Unpacking the syllabus Implications for Senior School practices and ass...QCE – Unpacking the syllabus Implications for Senior School practices and ass...
QCE – Unpacking the syllabus Implications for Senior School practices and ass...
 
ASP.NET Core Interview Questions PDF By ScholarHat.pdf
ASP.NET Core Interview Questions PDF By ScholarHat.pdfASP.NET Core Interview Questions PDF By ScholarHat.pdf
ASP.NET Core Interview Questions PDF By ScholarHat.pdf
 
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
Codeavour 5.0 International Impact Report - The Biggest International AI, Cod...
 
A beginner’s guide to project reviews - everything you wanted to know but wer...
A beginner’s guide to project reviews - everything you wanted to know but wer...A beginner’s guide to project reviews - everything you wanted to know but wer...
A beginner’s guide to project reviews - everything you wanted to know but wer...
 
MathematicsGrade7-Presentation-July-12024.pptx
MathematicsGrade7-Presentation-July-12024.pptxMathematicsGrade7-Presentation-July-12024.pptx
MathematicsGrade7-Presentation-July-12024.pptx
 
11. Post harvest quality, Quality criteria and Judgement.pptx
11. Post harvest quality, Quality criteria and Judgement.pptx11. Post harvest quality, Quality criteria and Judgement.pptx
11. Post harvest quality, Quality criteria and Judgement.pptx
 
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
Dr. Nasir Mustafa CERTIFICATE OF APPRECIATION "NEUROANATOMY"
 
How to Manage Line Discount in Odoo 17 POS
How to Manage Line Discount in Odoo 17 POSHow to Manage Line Discount in Odoo 17 POS
How to Manage Line Discount in Odoo 17 POS
 
Our Guide to the July 2024 USPS® Rate Change
Our Guide to the July 2024 USPS® Rate ChangeOur Guide to the July 2024 USPS® Rate Change
Our Guide to the July 2024 USPS® Rate Change
 
Introduction to Google Productivity Tools for Office and Personal Use
Introduction to Google Productivity Tools for Office and Personal UseIntroduction to Google Productivity Tools for Office and Personal Use
Introduction to Google Productivity Tools for Office and Personal Use
 
Introduction to Banking System in India.ppt
Introduction to Banking System in India.pptIntroduction to Banking System in India.ppt
Introduction to Banking System in India.ppt
 
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
BÀI TẬP BỔ TRỢ 4 KỸ NĂNG TIẾNG ANH LỚP 12 - GLOBAL SUCCESS - FORM MỚI 2025 - ...
 
Parkinson Disease & Anti-Parkinsonian Drugs.pptx
Parkinson Disease & Anti-Parkinsonian Drugs.pptxParkinson Disease & Anti-Parkinsonian Drugs.pptx
Parkinson Disease & Anti-Parkinsonian Drugs.pptx
 
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptxSD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
SD_Integrating 21st Century Skills in Classroom-based Assessment.pptx
 

Ch14

  • 2. Monetary Measures of Gains-toTrade  You can buy as much gasoline as you wish at $1 per gallon once you enter the gasoline market.  Q: What is the most you would pay to enter the market?
  • 3. Monetary Measures of Gains-toTrade  A: You would pay up to the dollar value of the gains-to-trade you would enjoy once in the market.  How can such gains-to-trade be measured?
  • 4. Monetary Measures of Gains-toTrade  Three such measures are: Consumer’s Surplus Equivalent Variation, and Compensating Variation.  Only in one special circumstance do these three measures coincide.
  • 5. $ Equivalent Utility Gains  Suppose gasoline can be bought only in lumps of one gallon.  Use r1 to denote the most a single consumer would pay for a 1st gallon -- call this her reservation price for the 1st gallon.  r1 is the dollar equivalent of the marginal utility of the 1st gallon.
  • 6. $ Equivalent Utility Gains  Now that she has one gallon, use r2 to denote the most she would pay for a 2nd gallon -- this is her reservation price for the 2nd gallon.  r2 is the dollar equivalent of the marginal utility of the 2nd gallon.
  • 7. $ Equivalent Utility Gains  Generally, if she already has n-1 gallons of gasoline then rn denotes the most she will pay for an nth gallon.  rn is the dollar equivalent of the marginal utility of the nth gallon.
  • 8. $ Equivalent Utility Gains  r1 + … + rn will therefore be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $0.  So r1 + … + rn - pGn will be the dollar equivalent of the total change to utility from acquiring n gallons of gasoline at a price of $pG each.
  • 9. $ Equivalent Utility Gains A plot of r1, r2, … , rn, … against n is a reservation-price curve. This is not quite the same as the consumer’s demand curve for gasoline.
  • 10. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline 10 r1 8 r2 6 r3 4 r4 2 r5 0 r6 1 2 3 4 5 Gasoline (gallons) 6
  • 11. $ Equivalent Utility Gains  What is the monetary value of our consumer’s gain-to-trading in the gasoline market at a price of $pG?
  • 12. $ Equivalent Utility Gains  The dollar equivalent net utility gain for the 1st gallon is $(r1 - pG)  and  and is $(r2 - pG) for the 2nd gallon, so on, so the dollar value of the gain-to-trade is $(r1 - pG) + $(r2 - pG) + … for as long as rn - pG > 0.
  • 13. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline 10 r1 8 r2 6 r3 4 r4 2 r5 0 r6 pG 1 2 3 4 5 Gasoline (gallons) 6
  • 14. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline 10 r1 8 r2 6 r3 4 r4 2 r5 0 r6 pG 1 2 3 4 5 Gasoline (gallons) 6
  • 15. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline $ value of net utility gains-to-trade 10 r1 8 r2 6 r3 4 r4 2 r5 0 r6 pG 1 2 3 4 5 Gasoline (gallons) 6
  • 16. $ Equivalent Utility Gains  Now suppose that gasoline is sold in half-gallon units.  r1, r2, … , rn, … denote the consumer’s reservation prices for successive half-gallons of gasoline.  Our consumer’s new reservation price curve is
  • 17. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline 10 r1 8 r3 6 r5 4 r7 2 r9 0 r11 1 2 3 4 5 6 7 8 9 10 11 Gasoline (half gallons)
  • 18. $ Equivalent Utility Gains ($) Res. Values Reservation Price Curve for Gasoline 10 r1 8 r3 6 r5 4 r7 2 r9 0 r11 pG 1 2 3 4 5 6 7 8 9 10 11 Gasoline (half gallons)
  • 19. $ Equivalent Utility Gains ($) Res. Values 10 r1 8 r3 6 r5 4 r7 2 r9 0 r11 Reservation Price Curve for Gasoline $ value of net utility gains-to-trade pG 1 2 3 4 5 6 7 8 9 10 11 Gasoline (half gallons)
  • 20. $ Equivalent Utility Gains  And if gasoline is available in onequarter gallon units ...
  • 21. $ Equivalent Utility Gains Reservation Price Curve for Gasoline 10 8 ($) Res. 6 Values 4 2 0 1 2 3 4 5 6 7 8 9 10 11 Gasoline (one-quarter gallons)
  • 22. $ Equivalent Utility Gains Reservation Price Curve for Gasoline 10 8 ($) Res. 6 Values 4 pG 2 0 1 2 3 4 5 6 7 8 9 10 11 Gasoline (one-quarter gallons)
  • 23. $ Equivalent Utility Gains Reservation Price Curve for Gasoline 10 $ value of net utility gains-to-trade 8 ($) Res. 6 Values 4 pG 2 0 Gasoline (one-quarter gallons)
  • 24. $ Equivalent Utility Gains  Finally, if gasoline can be purchased in any quantity then ...
  • 25. $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline Gasoline
  • 26. $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline pG Gasoline
  • 27. $ Equivalent Utility Gains ($) Res. Prices Reservation Price Curve for Gasoline $ value of net utility gains-to-trade pG Gasoline
  • 28. $ Equivalent Utility Gains  Unfortunately, estimating a consumer’s reservation-price curve is difficult,  so, as an approximation, the reservation-price curve is replaced with the consumer’s ordinary demand curve.
  • 29. Consumer’s Surplus A consumer’s reservation-price curve is not quite the same as her ordinary demand curve. Why not?  A reservation-price curve describes sequentially the values of successive single units of a commodity.  An ordinary demand curve describes the most that would be paid for q units of a commodity purchased simultaneously.
  • 30. Consumer’s Surplus  Approximating the net utility gain area under the reservation-price curve by the corresponding area under the ordinary demand curve gives the Consumer’s Surplus measure of net utility gain.
  • 31. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline Gasoline
  • 32. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline pG Gasoline
  • 33. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade pG Gasoline
  • 34. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade Consumer’s Surplus pG Gasoline
  • 35. Consumer’s Surplus ($) Reservation price curve for gasoline Ordinary demand curve for gasoline $ value of net utility gains-to-trade Consumer’s Surplus pG Gasoline
  • 36. Consumer’s Surplus  The difference between the consumer’s reservation-price and ordinary demand curves is due to income effects.  But, if the consumer’s utility function is quasilinear in income then there are no income effects and Consumer’s Surplus is an exact $ measure of gains-to-trade.
  • 37. Consumer’s Surplus The consumer’s utility function is quasilinear in x2. U( x1 , x 2 ) = v( x1 ) + x 2 Take p2 = 1. Then the consumer’s choice problem is to maximize U( x1 , x 2 ) = v( x1 ) + x 2 subject to p1x1 + x 2 = m.
  • 38. Consumer’s Surplus The consumer’s utility function is quasilinear in x2. U( x1 , x 2 ) = v( x1 ) + x 2 Take p2 = 1. Then the consumer’s choice problem is to maximize U( x1 , x 2 ) = v( x1 ) + x 2 subject to p1x1 + x 2 = m.
  • 39. Consumer’s Surplus That is, choose x1 to maximize v( x1 ) + m − p1x1 . The first-order condition is v'( x1 ) − p1 = 0 That is, p1 = v'( x1 ). This is the equation of the consumer’s ordinary demand for commodity 1.
  • 40. Consumer’s Surplus p1 Ordinary demand curve, p1 = v'( x1 ) CS p' 1 x' 1 x* 1
  • 41. Consumer’s Surplus p1 Ordinary demand curve, p1 = v'( x1 ) x' v'( x ) dx − p' x' CS = ∫0 1 1 1 1 1 CS p' 1 x' 1 x* 1
  • 42. Consumer’s Surplus p1 Ordinary demand curve, p1 = v'( x1 ) x' v'( x ) dx − p' x' CS = ∫0 1 1 1 1 1 = v( x' ) − v( 0 ) − p' x' 1 1 1 CS p' 1 x' 1 x* 1
  • 43. Consumer’s Surplus p1 p' 1 Ordinary demand curve, p1 = v'( x1 ) x' v'( x ) dx − p' x' CS = ∫0 1 1 1 1 1 = v( x' ) − v( 0 ) − p' x' 1 1 1 is exactly the consumer’s utility CS gain from consuming x1’ units of commodity 1. x' 1 x* 1
  • 44. Consumer’s Surplus  Consumer’s Surplus is an exact dollar measure of utility gained from consuming commodity 1 when the consumer’s utility function is quasilinear in commodity 2.  Otherwise Consumer’s Surplus is an approximation.
  • 45. Consumer’s Surplus  The change to a consumer’s total utility due to a change to p1 is approximately the change in her Consumer’s Surplus.
  • 46. Consumer’s Surplus p1 p1(x1), the inverse ordinary demand curve for commodity 1 p' 1 x' 1 x* 1
  • 48. Consumer’s Surplus p1 p1(x1) p" CS after 1 p' 1 x" 1 x' 1 x* 1
  • 49. Consumer’s Surplus p1 p1(x1), inverse ordinary demand curve for commodity 1. p" 1 p' 1 Lost CS x" 1 x' 1 x* 1
  • 50. x* 1 Consumer’s Surplus x' 1 x1*(p1), the consumer’s ordinary demand curve for commodity 1. " p1 ' p1 ∆CS = ∫ x" 1 Lost CS p' 1 p" 1 * x1(p1)dp1 measures the loss in Consumer’s Surplus. p1
  • 51. Compensating Variation and Equivalent Variation  Two additional dollar measures of the total utility change caused by a price change are Compensating Variation and Equivalent Variation.
  • 52. Compensating Variation  p1 rises.  Q: What is the least extra income that, at the new prices, just restores the consumer’s original utility level?
  • 53. Compensating Variation  p1 rises.  Q: What is the least extra income that, at the new prices, just restores the consumer’s original utility level?  A: The Compensating Variation.
  • 54. Compensating Variation x2 p1=p1’ p2 is fixed. m1 = p' x' + p 2x'2 1 1 x'2 u1 x' 1 x1
  • 55. Compensating Variation p1=p1’ p1=p1” x2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 x'2 u1 u2 x" 1 x' 1 x1
  • 56. Compensating Variation p1=p1’ p1=p1” x2 x'" 2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 " '" m2 = p1x1 x'2 u1 u2 x" x'" 1 1 x' 1 x1 '" + p2 x 2
  • 57. Compensating Variation p1=p1’ p1=p1” x2 x'" 2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 " '" m2 = p1x1 x'2 '" + p2 x 2 u1 u2 x" x'" 1 1 x' 1 CV = m2 - m1. x1
  • 58. Equivalent Variation  p1 rises.  Q: What is the least extra income that, at the original prices, just restores the consumer’s original utility level?  A: The Equivalent Variation.
  • 59. Equivalent Variation x2 p1=p1’ p2 is fixed. m1 = p' x' + p 2x'2 1 1 x'2 u1 x' 1 x1
  • 60. Equivalent Variation p1=p1’ p1=p1” x2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 x'2 u1 u2 x" 1 x' 1 x1
  • 61. Equivalent Variation p1=p1’ p1=p1” x2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 m2 = p' x'" + p 2x'" 1 1 2 x'2 x'" 2 u1 u2 x" 1 x'" x' 1 1 x1
  • 62. Equivalent Variation p1=p1’ p1=p1” x2 p2 is fixed. m1 = p' x' + p 2x'2 1 1 = p"x" + p 2x" 1 1 2 x" 2 m2 = p' x'" + p 2x'" 1 1 2 x'2 x'" 2 u1 u2 x" 1 x'" x' 1 1 EV = m1 - m2. x1
  • 63. Consumer’s Surplus, Compensating Variation and Equivalent Variation  Relationship 1: When the consumer’s preferences are quasilinear, all three measures are the same.
  • 64. Consumer’s Surplus, Compensating Variation and Equivalent Variation  Consider first the change in Consumer’s Surplus when p1 rises from p1’ to p1”.
  • 65. Consumer’s Surplus, Compensating Variation and Equivalent Variation If U( x1 , x 2 ) = v( x1 ) + x 2 then ' ' ' ' CS( p1 ) = v( x1 ) − v( 0 ) − p1x1
  • 66. Consumer’s Surplus, Compensating Variation and Equivalent Variation If U( x1 , x 2 ) = v( x1 ) + x 2 then ' ' ' ' CS( p1 ) = v( x1 ) − v( 0 ) − p1x1 and so the change in CS when p1 rises from p1’ to p1” is ' " ∆CS = CS( p1 ) − CS( p1 )
  • 67. Consumer’s Surplus, Compensating Variation and Equivalent Variation If U( x1 , x 2 ) = v( x1 ) + x 2 then ' ' ' ' CS( p1 ) = v( x1 ) − v( 0 ) − p1x1 and so the change in CS when p1 rises from p1’ to p1” is ' " ∆CS = CS( p1 ) − CS( p1 ) [ = v( x' ) − v( 0 ) − p' x' − v( x" ) − v( 0 ) − p"x" 1 1 1 1 1 1 ]
  • 68. Consumer’s Surplus, Compensating Variation and Equivalent Variation If U( x1 , x 2 ) = v( x1 ) + x 2 then ' ' ' ' CS( p1 ) = v( x1 ) − v( 0 ) − p1x1 and so the change in CS when p1 rises from p1’ to p1” is ' " ∆CS = CS( p1 ) − CS( p1 ) [ = v( x' ) − v( 0 ) − p' x' − v( x" ) − v( 0 ) − p"x" 1 1 1 1 1 1 = v( x' ) − v( x" ) − ( p' x' − p"x" ). 1 1 1 1 1 1 ]
  • 69. Consumer’s Surplus, Compensating Variation and Equivalent Variation  Now consider the change in CV when p1 rises from p1’ to p1”.  The consumer’s utility for given p 1 is * * v( x1 ( p1 )) + m − p1x1 ( p1 ) and CV is the extra income which, at the new prices, makes the consumer’s utility the same as at the old prices. That is, ...
  • 70. Consumer’s Surplus, Compensating Variation and Equivalent Variation ' ' ' v( x1 ) + m − p1x1 " " " = v( x1 ) + m + CV − p1x1 .
  • 71. Consumer’s Surplus, Compensating Variation and Equivalent Variation ' ' ' v( x1 ) + m − p1x1 " " " = v( x1 ) + m + CV − p1x1 . So ' " ' ' " " CV = v( x1 ) − v( x1 ) − ( p1x1 − p1x1 ) = ∆CS.
  • 72. Consumer’s Surplus, Compensating Variation and Equivalent Variation  Now consider the change in EV when p1 rises from p1’ to p1”.  The consumer’s utility for given p 1 is * * v( x1 ( p1 )) + m − p1x1 ( p1 ) and EV is the extra income which, at the old prices, makes the consumer’s utility the same as at the new prices. That is, ...
  • 73. Consumer’s Surplus, Compensating Variation and Equivalent Variation ' ' ' v( x1 ) + m − p1x1 " " " = v( x1 ) + m + EV − p1x1 .
  • 74. Consumer’s Surplus, Compensating Variation and Equivalent Variation ' ' ' v( x1 ) + m − p1x1 " " " = v( x1 ) + m + EV − p1x1 . That is, EV = v( x' ) − v( x" ) − ( p' x' − p"x" ) 1 1 1 1 1 1 = ∆CS.
  • 75. Consumer’s Surplus, Compensating Variation and Equivalent Variation So when the consumer has quasilinear utility, CV = EV = ∆CS. But, otherwise, we have: Relationship 2: In size, EV < ∆CS < CV.
  • 76. Producer’s Surplus  Changes in a firm’s welfare can be measured in dollars much as for a consumer.
  • 77. Producer’s Surplus Output price (p) Marginal Cost y (output units)
  • 78. Producer’s Surplus Output price (p) Marginal Cost p' y' y (output units)
  • 79. Producer’s Surplus Output price (p) Marginal Cost p' Revenue p'y' = y' y (output units)
  • 80. Producer’s Surplus Output price (p) Marginal Cost p' Variable Cost of producing y’ units is the sum of the marginal costs y' y (output units)
  • 81. Producer’s Surplus Output price (p) Revenue less VC is the Producer’s Surplus. p' Marginal Cost Variable Cost of producing y’ units is the sum of the marginal costs y' y (output units)