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Expected Consumer's Surplus as an Approximate Welfare Measure

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Abstract
Willig (1976) argues that the change in consumerís 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 consumerís surplus is small. If the price of a good is random, then the change in (ECS) equals a consumerís 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 over income gambles. We ask how well the change in ECS approximates the willingness to pay if these conditions fail. We show that the di§erence between the change in ECS and willingness to pay is of higher order than the L1 distance between the distributions if and only if the indirect utility function is additively separable in the price and income. If, however, this knife-edge condition fails, then the percentage error from using ECS can be arbitrarily large for small changes in the price distribution. Moreover, we show that the percentage error can be large even if risk aversion, the goodís income elasticity of demand and its budget share are all small. Thus, the widespread use of expected consumerís surplus as a welfare measure under uncertainty cannot be justified by approximation arguments inspired by those formulated for nonrandom prices.

Suggested Citation

  • Edward Schlee, "undated". "Expected Consumer's Surplus as an Approximate Welfare Measure," Working Papers 2133375, Department of Economics, W. P. Carey School of Business, Arizona State University.
  • Handle: RePEc:asu:wpaper:2133375
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    References listed on IDEAS

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    1. Rogerson, William P, 1980. "Aggregate Expected Consumer Surplus as a Welfare Index with an Application to Price Stabilization," Econometrica, Econometric Society, vol. 48(2), pages 423-436, March.
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    7. William Novshek & Hugo Sonnenschein, 1982. "Fulfilled Expectations Cournot Duopoly with Information Acquisition and Release," Bell Journal of Economics, The RAND Corporation, vol. 13(1), pages 214-218, Spring.
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    Cited by:

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    3. Marco de Pinto & Laszlo Goerke, 2022. "Cost uncertainty in an oligopoly with endogenous entry," Bulletin of Economic Research, Wiley Blackwell, vol. 74(4), pages 927-948, October.
    4. Anthony Creane & Kaz Miyagiwa, 2020. "Export versus FDI: Learning through propinquity," International Journal of Economic Theory, The International Society for Economic Theory, vol. 16(4), pages 361-379, December.
    5. Ioan Lucian ALEXA, 2015. "The effects of competition regulations on mobile telecommunication markets," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania / Editura Economica, vol. 0(2(603), S), pages 303-310, Summer.
    6. Hayashi, Takashi, 2014. "Consumer surplus analysis under uncertainty: A general equilibrium perspective," Journal of Mathematical Economics, Elsevier, vol. 55(C), pages 154-164.
    7. repec:agr:journl:v:2(602):y:2015:i:2(602):p:303-310 is not listed on IDEAS
    8. 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.

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    JEL classification:

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

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