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Expected consumer’s surplus as an approximate welfare measure

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  • Edward Schlee

Abstract

Willig (1976) argues that the change in consumerís surplus is often a good approximation to the willingness to pay for a price change: if the income elasticity of demand is small, or the price change is small, then the percentage error from using consumerís surplus is small. If the price of a good is random, then the change in (ECS) equals a consumerís willingness to pay for a change in its distribution if and only if its demand is independent of income and the consumer is risk neutral over income gambles. We ask how well the change in ECS approximates the willingness to pay if these conditions fail. We show that the di§erence between the change in ECS and willingness to pay is of higher order than the L1 distance between the distributions if and only if the indirect utility function is additively separable in the price and income. If, however, this knife-edge condition fails, then the percentage error from using ECS can be arbitrarily large for small changes in the price distribution. Moreover, we show that the percentage error can be large even if risk aversion, the goodís income elasticity of demand and its budget share are all small. Thus, the widespread use of expected consumerís surplus as a welfare measure under uncertainty cannot be justified by approximation arguments inspired by those formulated for nonrandom prices.
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  • Edward Schlee, 2008. "Expected consumer’s surplus as an approximate welfare measure," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 34(1), pages 127-155, January.
    • Handle: RePEc:spr:joecth:v:34:y:2008:i:1:p:127-155
    DOI: 10.1007/s00199-007-0210-2
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    Cited by:

    1. Marco de Pinto & Laszlo Goerke, 2022. "Cost uncertainty in an oligopoly with endogenous entry," Bulletin of Economic Research, Wiley Blackwell, vol. 74(4), pages 927-948, October.
    2. Anthony Creane & Kaz Miyagiwa, 2020. "Export versus FDI: Learning through propinquity," International Journal of Economic Theory, The International Society for Economic Theory, vol. 16(4), pages 361-379, December.
    3. Ioan Lucian ALEXA, 2015. "The effects of competition regulations on mobile telecommunication markets," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(2(603), S), pages 303-310, Summer.
    4. Soetevent, Adriaan R. & Bruzikas, Tadas, 2016. "Risk and Loss Aversion, Price Uncertainty and the Implications for Consumer Search," Research Report 16015-EEF, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    5. repec:agr:journl:v:2(602):y:2015:i:2(602):p:303-310 is not listed on IDEAS
    6. Juliet Elu & Gregory Price, 2015. "Consumer’s Surplus with a Racial Apology? Black Relative to Non-Black Inequality in the Welfare Gains of Fuel-Efficient Cars and Trucks," The Review of Black Political Economy, Springer;National Economic Association, vol. 42(1), pages 135-154, June.
    7. Dimitrova, Magdalena & Schlee, Edward E., 2003. "Monopoly, competition and information acquisition," International Journal of Industrial Organization, Elsevier, vol. 21(10), pages 1623-1642, December.
    8. CREANE, Anthony & MIYAGIWA, Kaz, 2015. "Exporting versus foreign direct investment: Learning through propinquity," Discussion paper series 2015-01, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
    9. Anthony Creane & Thomas D. Jeitschko, 2016. "Endogenous Entry in Markets with Unobserved Quality," Journal of Industrial Economics, Wiley Blackwell, vol. 64(3), pages 494-519, September.
    10. Hayashi, Takashi, 2014. "Consumer surplus analysis under uncertainty: A general equilibrium perspective," Journal of Mathematical Economics, Elsevier, vol. 55(C), pages 154-164.

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    More about this item

    Keywords

    Expected consumer’s surplus; Welfare; Uncertainty; Local cost-benefit analysis; D6; D8;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D6 - Microeconomics - - Welfare Economics

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