question archive Q6) Explain in your own words the difference between the compensating variation and equivalent variation of a price increase
Q6) Explain in your own words the difference between the compensating variation and equivalent variation of a price increase
Subject:EconomicsPrice: Bought3
Q6) Explain in your own words the difference between the compensating variation and equivalent variation of a price increase. Compensating variation measures the amount of money a consumer would need to receive to be compensated (in utility terms] for an increase in the price of a good. The compensating variation gives us thus a monetary measure of the welfare effect of the increase in price. It is given by the vertical difference between the intercepts with the y-axis of the original budget constraint before the price change and that of the (arti?cial) budget constraint after the price increase that we draw to pin down the substitution effect of a price change. The equivalent variation of the price increase corresponds to the amount of money a consumer is willing to pay to avoid an increase in the price of a good. It is given by the vertical difference between the intercepts with the y-axis of the original budget constraint before the price change and that of the budget constraint that has the same slope as the original one but that is tangent to the indifference curve corresponding to the new equilibrium consumption choice of the consumer after a price change.
