A Note on Price Stability and Consumer's Welfare

Abstract

THE EFFECTS OF COMMODITY PRICE STABILIZATION on an individual consumer's welfare has been controversial ever since the issue was first analyzed by Waugh [15]. The early approach of Waugh, which was based explicitly on expected consumer's surplus and ignored the production side of the economy, has since been generalized in several respects. For instance, Turnovsky, Shalit, and Schmitz (hereafter T-S-S) [14] have suggested an approach that utilizes the indirect utility function of a single individual. By focusing on a single consumer and comparing risk-no risk situations where prices are random variables, they derive interesting and useful results that express conditions for the desirability of price stabilization in terms of the familiar Arrow-Pratt measure of relative risk aversion, price and income elasticities, and budget shares. Although the approach of T-S-S provides useful information about an individual's preference for or against price stability, it does not provide information about a group of heterogeneous consumers' preference for price stability. The approach of T-S-S also assumes that perfect price stabilization is possible; indeed, in many cases government policy may serve to partially stabilize prices, but not perfectly stabilize prices.2 Thus the analysis of T-S-S does not address comparisons of risk-risk situations (the comparisons of unstable versus partially stabilized prices) nor comparisons when there are heterogeneous individuals. Recently, Newbery and Stiglitz [9, 10] have used stochastic dominance rules to analyze mean preserving partial price stabilization schemes. The purpose of the present note is to extend the T-S-S and Newbery-Stiglitz analysis by providing comparisons of partial price stabilization policies that affect multiple prices in non-mean preserving ways. Since an excellent survey of the stabilization literature appears in Newbery and Stiglitz [10], we proceed with the results of our analysis.