CU-Boulder ECON 4545 - Defining the compensating variation (8 pages)

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Defining the compensating variation



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Defining the compensating variation

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Pages:
8
School:
University of Colorado at Boulder
Course:
Econ 4545 - Environmental Economics

Unformatted text preview:

De ning the compensating variation cv and the equivalent variation ev de ncvandev tex and pdf October 21 2014 More complicated stu but important stu for you to understand I mislead you the area under the inverse demand function marginal willingnessto pay function only approximates consumer s surplus I lied It turn out that CS cannot be de ned as an area under Marshallian demand function Consider the inverse demand curves for Diet Coke and Diet Pepsi assuming each has a price and then the price of Coke rises The problem is that when the price of Coke changes this causes the demand curve for Pepsi to shift and this causes the price of Pepsi to change which then causes the demand curve for Coke to shift And vice versa It turn out that the CS as an area under demand functions is not well de ned So a new money measure of an individual s utility change needed to be found What properties would one like this measure to have 1 Postive for improvements policies that cause the individual s utility to increase 2 Negative for deteriorations policies that cause the individual s utility to decrease 3 The money measure should be an adjustment to your income such that after the adjustment the individual is indi erent between the original state without the policy in place and the new state with the policy in place 4 The money measure is well de ned for both improvements and deteriorations There are two CS measures that t the bill the compensating variation cv and the equivalent variation ev They di er in terms of whether the income adjustment occurs in the original state or the new state Simple de nitions of the compensating and equivalent variation 1 1 The cv and ev are both measures of consumer s surplus The cvi and evi are calculated for individual i for a change in the state of the world 1 1 States of the world A state of the world is all that in uences your life that is exogenous to you What do we mean by a change in the state of the world We will de ne a state of the world from



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