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Prices and Welfare

Author

Listed:
  • Abdelkrim Araar

    (Laval University)

  • Paolo Verme

    (The World Bank)

Abstract

What is the welfare effect of a price change? This simple question is one of the most relevant and controversial questions in microeconomic theory and its different answers can lead to severe heterogeneity in empirical results. This paper returns to this question with the objective of providing a general framework for the use of theoretical contributions in empirical works, with a particular focus on poor people and poor countries. Welfare measures (such as Equivalent Variation or Consumer's Surplus) and computational methods (such as Taylor's approximations or the Vartia method) are compared to test how these choices result in different welfare measurement under different price shock scenarios. As a rule of thumb and irrespective of parameter choices, welfare measures converge to approximately the same result for price changes below 10 percent. Above this threshold, these measures start to diverge significantly. Budget shares play an important role in explaining such divergence, whereas the choice of demand system has a minor role. Under standard utility assumptions, the Laspeyers and Paasche variations are always the outer bounds of welfare estimates and consumer surplus is always the median estimate. The paper also introduces a new simple welfare approximation, clarifies the relation between Taylor's approximations and the income and substitution effects, and provides an example for treating nonlinear pricing. Stata codes for all computations are provided in annex.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Abdelkrim Araar & Paolo Verme, 2019. "Prices and Welfare," Springer Books, Springer, number 978-3-030-17423-1, January.
    • Handle: RePEc:spr:sprbok:978-3-030-17423-1
    DOI: 10.1007/978-3-030-17423-1
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    Cited by:

    1. Rita Motzigkeit Gonzalez, 2016. "Welfare effects of changed prices The “Tortilla Crisis" revisited," Working Papers 167, Bavarian Graduate Program in Economics (BGPE).
    2. Rodríguez-Castelán, Carlos & Araar, Abdelkrim & Malásquez, Eduardo A. & Granguillhome Ochoa, Rogelio, 2022. "Competition reform and household welfare: A microsimulation analysis of the telecommunication sector in Ethiopia," Telecommunications Policy, Elsevier, vol. 46(2).
    3. Saelim, Supawan, 2019. "Carbon tax incidence on household consumption: Heterogeneity across socio-economic factors in Thailand," Economic Analysis and Policy, Elsevier, vol. 62(C), pages 159-174.
    4. Nikmatul Khoiriyah & Ratya Anindita & Nuhfil Hanani & Abdul Wahib Muhaimin, . "Animal Food Demand in Indonesia: A Quadratic Almost Ideal Demand System Approach," AGRIS on-line Papers in Economics and Informatics, Czech University of Life Sciences Prague, Faculty of Economics and Management, vol. 12(2).
    5. Abdelkrim Araar & Paolo Verme, 2019. "Prices and welfare: a comparative analysis of measures and computational methods," Empirical Economics, Springer, vol. 57(4), pages 1077-1101, October.
    6. Aldubyan, Mohammad & Gasim, Anwar, 2021. "Energy price reform in Saudi Arabia: Modeling the economic and environmental impacts and understanding the demand response," Energy Policy, Elsevier, vol. 148(PB).
    7. Rodriguez Castelan,Carlos & Araar,Abdelkrim & Malasquez Carbonel,Eduardo Alonso & Olivieri,Sergio Daniel & Vishwanath,Tara, 2019. "Distributional Effects of Competition : A Simulation Approach," Policy Research Working Paper Series 8838, The World Bank.

    More about this item

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis

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