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Expected Consumer's Surplus as an Approximate Welfare Measure

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  • Edward E Schlee

Abstract

Willig (1976) argues that the change in consumer's 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 consumer's surplus is small. If the price of a good is random, then the change in expected consumer's surplus (ECS) equals a consumer's 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. We ask how well the change in ECS approximates the willingness to pay if these conditions fail. We show that the difference between the change in ECS and willingness to pay is of higher order than the L_1 distance between the price distributions if and only if the indirect utility function is additively separable in the price and income. If additively separability fails, then the percentage error from using ECS is unbounded for small distribution changes, and is always nonzero in the limit except for knife-edge cases. If, however, the distribution change is smooth on the space of random variables, and either the initial price is nonrandom or state-contingent payments are possible, then the change in ECS might approximate the willingness to pay well. Unfortunately, this smoothness condition necessarily fails in some important applications of ECS

Suggested Citation

  • Edward E Schlee, 2004. "Expected Consumer's Surplus as an Approximate Welfare Measure," Econometric Society 2004 North American Summer Meetings 97, Econometric Society.
  • Handle: RePEc:ecm:nasm04:97
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    References listed on IDEAS

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    Cited by:

    1. Dimitrova, Magdalena & Schlee, Edward E., 2003. "Monopoly, competition and information acquisition," International Journal of Industrial Organization, Elsevier, vol. 21(10), pages 1623-1642, December.
    2. Anthony Creane & Kaz Miyagiwa, 2010. "Exporting Versus Foreign Direct Investment: Learning through Propinquity," Emory Economics 1010, Department of Economics, Emory University (Atlanta).
    3. 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.
    4. Hayashi, Takashi, 2014. "Consumer surplus analysis under uncertainty: A general equilibrium perspective," Journal of Mathematical Economics, Elsevier, vol. 55(C), pages 154-164.
    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. 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.

    More about this item

    Keywords

    Expected Consumer's Surplus; Welfare under Uncertainty;

    JEL classification:

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

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