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that's not homework.the reason for me posting here is only for learning.
show therelationship of the compensating variation to the consumer surplus
measure of the same price rise. What factors affect how close these
two measures are to each other.
anyone help?
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the compensating variation is the income you need to spend in order to restore you to the orginal indifferent curve and the Consumer Surplus is the areas left of the demand curve .but...is that any relationship between that???
Yes, there is a relationship between the compensating variation and the consumer surplus measure. Both of these concepts are used to measure the welfare changes for consumers due to a price rise.
1. Compensating Variation:
The compensating variation measures the minimum amount of additional income a consumer would need to receive in order to remain on the same level of utility or satisfaction after a price rise. It represents the monetary compensation required to offset the decrease in consumer welfare caused by the price increase.
2. Consumer Surplus:
Consumer surplus, on the other hand, is a measure of the net benefit or gain that consumers receive by purchasing a good or service at a given price. It is calculated as the difference between the maximum price consumers are willing to pay for a product and the actual price they pay.
Relationship between Compensating Variation and Consumer Surplus:
The relationship between the compensating variation and consumer surplus is that both measures reflect changes in consumer welfare resulting from a price change.
When there is a price increase, the compensating variation represents the amount of income needed to restore the consumer to their original level of utility or satisfaction. This implies that the consumer would need to receive additional income to compensate for the decrease in their welfare caused by the higher price.
On the other hand, the consumer surplus measure represents the net benefit or gain consumers receive from purchasing a product at a given price. When the price increases, ceteris paribus, the consumer surplus decreases as consumers are willing to pay less for the product.
The compensating variation and consumer surplus measures are related in the sense that they both capture the change in consumer welfare due to a price rise. However, the compensating variation is a monetary measure, representing the income needed to compensate for the decrease in welfare, while the consumer surplus is a concept that represents the net benefit gained by consumers.
Factors Affecting the Relationship:
The closeness of the two measures, compensating variation and consumer surplus, can be influenced by various factors, including:
1. The shape of the demand curve: The steepness or elasticity of the demand curve affects how much the compensating variation and consumer surplus measures diverge. For a more elastic demand curve, the compensating variation may be relatively smaller compared to the loss in consumer surplus.
2. Income changes: If there are changes in consumer income along with the price rise, it can affect the relationship between compensating variation and consumer surplus. If consumer income also increases, the compensating variation needed to restore utility may be smaller, resulting in a smaller discrepancy between the two measures.
3. Substitution possibilities: The availability of substitute goods or alternatives can affect the relationship between compensating variation and consumer surplus. If there are close substitutes for the product with the price increase, consumers may be more willing to switch to those substitutes, resulting in a smaller compensating variation compared to the loss in consumer surplus.
It is important to note that the relationship between compensating variation and consumer surplus is not always straightforward and can vary based on the specific circumstances and assumptions of the economic model being used to analyze the price change.