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Notes On EV:CV

CV and EV are measures of welfare change resulting from economic changes like price changes. CV is the amount of money that would need to be given to a consumer after a price increase to make them as well off as before. EV is the amount that would need to be taken from a consumer before a price decrease to leave them as well off as they would be after. Calculating CV and EV involves finding demand functions, plugging them into a utility function, and solving to find the income levels that equalize utility before and after the price change. These monetary measures allow economists to quantify how changes in prices impact consumer welfare.

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195 views13 pages

Notes On EV:CV

CV and EV are measures of welfare change resulting from economic changes like price changes. CV is the amount of money that would need to be given to a consumer after a price increase to make them as well off as before. EV is the amount that would need to be taken from a consumer before a price decrease to leave them as well off as they would be after. Calculating CV and EV involves finding demand functions, plugging them into a utility function, and solving to find the income levels that equalize utility before and after the price change. These monetary measures allow economists to quantify how changes in prices impact consumer welfare.

Uploaded by

laraib
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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EV and CV

Intermediate Microeconomics
Welfare and Economic Change
• Welfare = the well-being of a group
– Aggregate of utility

• Economic change is usually associated with


welfare change

• Two most common form of economic change


– Opening/closing of a market
– Change in the relative price of a good
• In case of economic change: individual moves
from one eqbm. to another
– Move from one indifference curve to another

• Change in welfare is measured by the


difference in utility

• Use transfer amount as the magnitude of


welfare change
CV and EV: Definitions
• CV: how much money we would have to give
the consumer after the price change to make
him just as well off as he was before the price
change

• EV: how much money would have to be taken


away from the consumer before the price
change to leave him as well off as he would be
after the price change.
CV and Welfare
EV and Welfare
• In the case of a positive economic change,
such as a fall in price, EV would be the
increase in income that would give the
consumer the same additional utility that
would happen if a price did fall.
• In the case of a negative economic change, EV
would be the amount of income that would be
taken away to lower the consumer’s utility to
the level that would happen if the change had
occurred.
Process for Calculating CV
1. Find demand functions
2. Plug demand functions into utility function
3. Solve for utility level achieved at the old
income and old prices
4. Set the value found in step 3 equal to the
utility function using new prices and unknown
new income, and solve for new income
5. Subtract old income from income found in
step 4 - that's CV
Process for Calculating EV
1. Find demand functions
2. Plug demand functions into utility function
3. Solve for utility level achieved at the old
income and new prices
4. Set the value found in step 3 equal to the
utility function using old prices and unknown
new income, and solve for new income
5. Subtract income found in step 4 from old
income - that's EV
Why Do We Care?
• CV and EV give us a monetary measure of that
abstract change in utility.
• So when someone asks “how much worse off
would a consumer be because of the price
change?", you can say
– “They're as worse off as they would have been if
we had taken EV away from their income" or
– “They're worse off such that we would need to
give them CV after prices changed to make them
just as happy as they were before"

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