Measuring consumer surplus in the case of addiction: A re-examination of the rational benchmark algebra

Measuring consumer surplus for addicted consumers is challenging because the presence of internalities makes the observed demand schedule a biased basis to estimate the actual welfare experienced by consumers. A common practice in literature consists of using non-addicted consumers as a rational benchmark. This short contribution points out some limitations of existing approaches and provides a revised measure that satisfies desirable properties in this rational benchmark framework. Comparative estimates based on data from the Australian Productivity Commission 1999 report on gambling indicate that existing approaches lead to largely overestimate the net consumer surplus. The new measure we propose is easy to implement and could be a useful tool when it comes to assessing welfare in addictive contexts.