What 's the difference between Compensated Variation (CV) and Equivalent Variation (EV) ?
Wikipedia has a fairly good explanation. Go to Wikipedia and search for "Compensating Variation"
The difference between Compensated Variation (CV) and Equivalent Variation (EV) lies in the perspective from which they are calculated, as well as the welfare changes they represent.
1. Compensated Variation (CV): CV measures the amount of money one would need to compensate an individual for a change in their welfare caused by a policy or event. In other words, it calculates the monetary value required to restore a person's utility level to what it was before the change occurred. CV takes into account both the positive and negative welfare effects experienced by an individual. For example, if a tax policy leads to a decrease in an individual's utility, the CV would represent the monetary compensation needed to offset that decrease.
To calculate CV, you need to follow these steps:
- Determine the individual's utility level before the policy or change.
- Measure the individual's utility level after the policy or change.
- Calculate the difference in utility levels.
- Assign a monetary value to the difference in utility to compensate for the welfare change.
2. Equivalent Variation (EV): EV measures the amount of money that an individual is indifferent to receiving, in order to achieve the same level of welfare as before a policy or event occurs. In other words, it calculates the amount of money that, if given to an individual, would make them as well-off after the change as they were before. EV captures only the negative welfare effects experienced by an individual. For example, if a tax policy leads to a decrease in an individual's utility, the EV would represent the amount of money needed to maintain the same utility level as before the tax was implemented.
To calculate EV, you need to follow these steps:
- Determine the individual's utility level before the policy or change.
- Calculate the monetary value of the individual's utility level after the policy or change.
- Determine the amount of money needed to restore the individual's utility to its initial level.
- This amount represents the Equivalent Variation.
To summarize, the key difference between CV and EV is that CV considers both positive and negative welfare effects, while EV only accounts for the negative welfare effects. CV calculates the monetary compensation needed to restore initial welfare, whereas EV determines the monetary value required to maintain the same welfare level as before.