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Welfare Estimation In A General Equilibrium Model With Cites


  • Oded Hochman



We show that current measures of welfare changes which are all based on the compensated variation (CV) and the equivalent variation (EV) do not apply to an economy with cities. In addition, since these measures are utilized in a partial equilibrium analysis they capture only part of the effect of a welfare change. We then define measures appropriate for an urban economy in a general equilibrium framework. We first construct for each city a cost function from which we derive a city’s and, after aggregation, the economy’s, demand functions. These demands are functions of nationwide prices and of either the unearned incomes (Marshalian demand curves) or of the utility levels (compensated demand curves). From the same cost functions we also derive the Marshalian and compensated supply curves. Each point on a Marshalian demand curve is an allocation designated by the price vector and the unearned income vector. An allocation is either in perfect equilibrium, when the marginal cost in each market is equal to the market price or, if the marginal cost differs from the market price in some markets, the allocation is in imperfect equilibrium and is inefficient. Imperfect markets can be improved by moving to other allocations on the same Marshalian demand function. We construct modified versions, such as mCV and mEV, of the welfare measures CV and EV, from which we define the modified economic surplus (mES) as the ultimate welfare measure. The mES is equal to the willingness to pay for the added product produced (i.e., the area between the Marshalian demand curve and the quantity-axis), minus the added costs of production in current prices and wages, and plus the change in the differential land rents (DLR) in the cities producing the good. The analysis is then extended to cases in which more than one market price changes. We also estimate secondary effects in imperfect markets in which the market price remains constant while the price in the primary market changes.

Suggested Citation

  • Oded Hochman, 2012. "Welfare Estimation In A General Equilibrium Model With Cites," Working Papers 1213, Ben-Gurion University of the Negev, Department of Economics.
  • Handle: RePEc:bgu:wpaper:1213

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    References listed on IDEAS

    1. David Albouy, 2009. "The Unequal Geographic Burden of Federal Taxation," Journal of Political Economy, University of Chicago Press, vol. 117(4), pages 635-667, August.
    2. Richard W. Blundell & Martin Browning & Ian A. Crawford, 2003. "Nonparametric Engel Curves and Revealed Preference," Econometrica, Econometric Society, vol. 71(1), pages 205-240, January.
    3. Henderson, J V, 1974. "The Sizes and Types of Cities," American Economic Review, American Economic Association, vol. 64(4), pages 640-656, September.
    4. Hochman, Oded, 1981. "Land rents, optimal taxation and local fiscal independence in an economy with local public goods," Journal of Public Economics, Elsevier, vol. 15(1), pages 59-85, February.
    5. Small, Kenneth A & Rosen, Harvey S, 1981. "Applied Welfare Economics with Discrete Choice Models," Econometrica, Econometric Society, vol. 49(1), pages 105-130, January.
    6. Willig, Robert D, 1976. "Consumer's Surplus without Apology," American Economic Review, American Economic Association, vol. 66(4), pages 589-597, September.
    7. Hanemann, W Michael, 1991. "Willingness to Pay and Willingness to Accept: How Much Can They Differ?," American Economic Review, American Economic Association, vol. 81(3), pages 635-647, June.
    8. Chipman, John S & Moore, James C, 1980. "Compensating Variation, Consumer's Surplus, and Welfare," American Economic Review, American Economic Association, vol. 70(5), pages 933-949, December.
    9. repec:wsi:wsbook:6953 is not listed on IDEAS
    10. Hausman, Jerry A, 1981. "Exact Consumer's Surplus and Deadweight Loss," American Economic Review, American Economic Association, vol. 71(4), pages 662-676, September.
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    More about this item


    City cost function; welfare measures; modified compensated variation; modified economic surplus; unearned income function; differential land rents; city size.;

    JEL classification:

    • R13 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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