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Introduction to Microeconomics (L11100)

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).

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Introduction to Microeconomics (L11100)

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  1. Introduction to Microeconomics (L11100) Section 3: Consumer Welfare and Household as Supplier Lectures 8 - 11

  2. 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. 3.1 Compensating & Equivalent Variations in Income 3.1.1 Defining CV and EV 3.1.2 Compensating Variation 3.1.3 Equivalent Variation 3.1.4 Examples

  4. 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

  5. 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. Real Income - the bundle of goods and services that can be bought. Along an indifference curve, real income is constant 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

  6. 3.1.2 Compensating Variation 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

  7. Income or All Other Goods U2 Compensating Variation CV NEW price ratio OLD indifference-curve U1 C A B BC1 1 BC3 3 BC2 QA 2

  8. 3.1.3 Equivalent Variation 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

  9. Income or All Other Goods U2 Equivalent Variation U1 OLD price ratio NEW indifference curve EV A B C BC1 3 1 BC3 2 BC2 QA

  10. 3.1.4 Examples

  11. Is a subsidised price for housing the same as a payment to homebuyers? U2 Cost of subsidy EV U1 Income or All Other Goods C B A BC2 BC3 BC1 Sq. Ms of Housing

  12. Pensioners: fuel gifts or cash payments to keep them warm? U3 Income or All Other Goods U1 A B C U2 BC1 BC2 Fuel Consumption Fuel Gift

  13. U2 CV U1 Income or All Other Goods C A B BC1 BC3 BC2 Fuel Consumption

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