Surplus Measures Research Articles

Efficiency versus Equity in Economic Policy Analysis

In this paper we outline a new approach to welfare economics. The purpose of welfare economics is to provide an ordering of alter native economic policies. The most desirable economic policy is the policy yielding the highest level of social welfare. This principle can be used to evaluate a specific policy change or to select the optimal policy from a set of alternatives. Dupuit (1969) originated the appraisal of alternative economic policies in terms of their impact on consumer welfare. He proposed to measure individual welfare on the basis of preferences revealed by consumer behavior. The prices faced by the consumer and the corresponding quantities demanded were used to obtain estimates of consumer's sur plus.1 Hicks (1942) introduced measures of consumer's surplus based on compensating and equivalent variations in income or total expenditure. The intuition underlying Hicks's approach to welfare economics is straightforward. Lev els of welfare before and after a change in economic policy can be ordered by compar ing the required levels of total expenditure. For Hicks's compensating variation the dif ference in total expenditure is evaluated at prices prevailing after the change in policy. For the equivalent variation the difference is evaluated at prices before the policy change. Chipman and Moore (1980) have shown that a necessary and sufficient condition for Hicks's compensating variation to provide an appropriate ordering of economic policies is that individual preferences are homothetic. Homothetic preferences are inconsistent with well established regularities in the behavior of individual consumers, such as those reviewed by Houthakker (1957). Chipman and Moore recommend Hicks's equivalent variation. The individual expenditure function intro duced by McKenzie (1957) provides the sim plest approach for implementing Hicks's measures of welfare. The expenditure func tion gives the minimum level of total expend iture required to attain a stipulated level of utility as a function of the prices faced by the consumer. This level of expenditure can be derived from the indirect utility function, which gives the maximum attainable utility level as a function of prices and total expend iture. Jorgenson, Lau, and Stoker (1980, 1981, 1982) have developed methods for construct ing indirect utility functions and individual expenditure functions for a population of consumers. Exact measures of compensating variations based on these methods were intro duced by Jorgenson, Lau, and Stoker (1980). The corresponding exact measures of equiv alent variations were introduced by Jorgen son, Lau, and Stoker (1981). We describe these measures in Section 2 below. The approach to welfare measurement originated by Dupuit is limited to individual welfare. Under the Pareto principle a change in economic policy can be recommended if all consuming units are at least as well off under the policy change and at least one consuming unit is better off. This principle provides a partial ordering of economic poli cies. To obtain a complete ordering we re quire the concept of a social welfare function originated by Bergson (1938) and discussed by Samuelson (1982-1983). A social welfare function gives the level of social welfare as a function of the distribution of individual welfare over the population of consumers. Social welfare functions incor porate the effects of changes in economic policy on the welfare of individual con sumers. A requirement often imposed on so cial welfare functions is that they must obey the Pareto principle. Social welfare functions also include the impacts of policy changes on

Errors in the Numerical Assessment of the Benefits of Price Stabilization

AbstractThis paper presents a simple computational procedure for determining a consumer's willingness to pay to have a price stabilization policy implemented. Numerical simulations are then provided which demonstrate that the commonly used expected surplus measures (whether Hicksian or Marshallian) can in fact seriously misstate the true benefits of price stabilization. These simulations also illustrate the extent to which the results may be dependent upon the assumptions made—implicitly or explicitly—regarding the consumer's attitudes toward risk, thereby underscoring the need to conduct sensitivity analyses to determine the robustness of cost‐benefit assessments with respect to these assumptions.

The Value of a Rational Expectations Forecast in a Risky Market: A Theoretical and Empirical Approach

The central focus of this paper is to develop an easily computable money metric of an agent's willingness to pay for information under risk, to extend this concept to the market, and to demonstrate its application in a simple twoequation econometric model of the U.S. fed cattle market. The paper draws on previous contributions to the theory of competitive firm under price uncertainty, namely Rothschild and Stiglitz, Sandmo, and more recently Pope (1978, 1980) and Pope, Chavas, and Just. The latter contributions provide insight into the econometric application of the theory and into the validity of producer surplus measures of firm welfare under risk. The conceptual approach presented in this paper facilitates empirical application. For a restricted class of utility functions, it is shown that the money metric of an agent's willingness to pay for additional information can be computed from the firm's risk-averse supply or factor demand function. While other studies (e.g., Hayami and Peterson, Freebairn, DeCanio) have derived welfare estimates of the value of a fore

A Note on Measuring Surplus Attributable to Differentiated Products

IN A RECENT article in this journal, F. M. Scherer [i] presented a study, both analytical and empirical, of the welfare economics of brand proliferation in the ready-to-eat cereal industry. Comparing estimates of contributions to surplus for new products with launching costs, Scherer concluded that during the period I958-70 most new cereal products were introduced at a net cost to society. Scherer's measure of a product's contribution to surplus is the consumer's surplus portion of the area under what he calls a ceteris paribus demand function (hereafter abbreviated as c.p.), the demand function for a single product holding the availability and prices of other products constant. Explicitly ignored in the calculation was the effect of price increases that generally accompanied the introduction of new products. Since consumers' surplus is reduced by an increase in price, Scherer felt that his estimates probably overstated new product benefits. Using a spatial model like the one employed by Scherer in the analytical portion of his paper, I show in Section II that while Scherer's measure does ignore lost consumer surplus due to price increases, and thus overstates the benefits to consumers, also ignored in Scherer's measure is an increase in producer surplus due to higher prices coupled with the appearance of new product variants. The net effect of the two omissions is ambiguous, leaving open the possibility that Scherer's measure of surplus is actually biased downward instead of upward as he supposes. An algebraic exercise reported in Section III shows that Scherer's measure underestimates a product's contribution to surplus if individual demand functions are linear in price and a spatial measure of product differences. Possible uses of c.p. demand functions for estimating the marginal benefits of differentiated products are discussed in Section IV.

Individual Welfare and the Demand for Financial Instruments

Individuals' demands for financial instruments are derived from a generalized Fisherian intertemporal consumption model. These are expressed in terms of the future value of the borrowing and lending in the initial period of an arbitrary time horizon, and are dependent on their current period prices or discount rates. An exact measure of the influence of these prices on individual welfare is constructed, observable surplus measures are defined which are analogous to ordinary consumer surplus, and the relationship of these observable surplus measures to the theoretically exact measure is specified. It is shown that with proper adaptation and interpretation, the entire spirit and substance of Willig's [11; 12] well-known solution to the problem of estimating individual welfare in ordinary markets can be carried over to the particular type of intertemporal decision-making which gives rise to market demands for financial instruments. Contrary to what appears to be generally presumed, proper observable surplus measures bearing a clear relationship to accepted theoretical measures of individual and social welfare are not properly calculated as simple areas under observable demands for financial instruments. However, it is shown that simple adaptations in the calculation of those areas suffice to enable precise welfare calculations to be made.

Comparing stochastic price regimes: The limitations of expected surplus measures

Marshallian consumer's surplus can often be defended as a useful approximation to Hicksian compensating variation. Under price uncertainty, however, expected compensating variation is not a generally valid welfare measure, and expected consumer's surplus cannot be justified as an approximation to a rigorous construct.

Mechanical Harvesting and the California Tomato Industry: A Simulation Analysis

AbstractSimulation analysis based on an econometric model was used to compare processing‐tomato industry performance with and without the development of mechanical harvesting and under differing wage scales. Expanded production under mechanical harvesting increased requirements for preharvest, seasonal and off‐season cannery, and assembly labor relative to continued hand harvest. This offset much, but not all, of the reduction in seasonal harvest labor. Employment shifted more toward jobs of higher skill and pay. Product prices were lower. Economic surplus measures suggest consumers have been the primary long‐run benefactors of mechanical harvest adoption.

Economic Welfare Evaluations for Producers under Uncertainty

AbstractThe validity of producer and consumer surplus measures of firm welfare under risk is examined. Under constant absolute risk aversion and output price uncertainty only, these measures are an exact measure of firm welfare as defined by compensating variation, equivalent variation or the change in the certainty equivalent. Under decreasing absolute risk aversion, qualitative comparisons of various measures are discussed. For example, producer's surplus as measured by the area above the uncompensated risk averse supply curve overstates the compensating variation of a change in expected price of output. Procedures for calculating firm welfare under production uncertainty and a variety of economic environments are proposed. Generally, these procedures are applicable only when absolute risk aversion is constant.

Efficient Methods of Measuring Welfare Change and Compensated Income in Terms of Ordinary Demand Functions

A utility maximizing consumer with a completely known system of ordinary demand functions q = h(p, C) is considered. Let (p?, qo) and (p', q') be two arbitrary equilibrium situations; the problem is to evaluate in which of the situations the utility is higher without knowing the utility function. Revealed preference theory tells that the ordinary demand functions (which are in principle observable) contain enough information to solve the problem. Remaining difficulties are therefore mainly computational. We present how the compensated income C i = C(p , qo) and the compensated demand = h(p', Cl1) are calculated with arbitrary accuracy using only the ordinary demand system. Our two efficient algorithms also have interesting interpretations in terms of index numbers and consumer surplus measures.

Some Hicksian and Marshallian consumer's surplus estimates in discrete choice

Abstract This note describes the theory and practice of applying the Hicksian approach to cost-benefit analysis to discrete choice models. It illustrates the technique with numerical estimates of Hicksian and Marshallian consumer's surplus measures based on computer simulations using real-world data.

ON THE RELATION BETWEEN HICKSIAN SURPLUS AND TRUE COST‐OF‐LIVING INDICES

ABSTRACTThis note demonstrates how recent results in the literature on true cost‐of‐living indices are of direct relevance to attempts to measure Hicks’compensating and equivalent variations because of the close inter‐relationship between the Hicksian surplus measures and true (or constant‐utility) price indices.

Simplified Measurement of Consumer Welfare Change

Various measures of consumer welfare change have been proposed in the literature, each claiming relative superiority in accurately reflecting the income equivalent of a welfare change. Selection of an appropriate measure in empirical research is complicated by both theoretical and estimation considerations. Compensating variation (CV) and equivalent variation (EV) as measures of consumer welfare change normally are preferred theoretically since they indicate whether or not a policy change is a potential Pareto improvement. However, use of Paasche Variation (PV), Laspeyres Variation (LV), or consumers' surplus (CS) measures is desirable empirically since less information is required for calculation. While Hicks long ago (1943) suggested that the distinctions among these measures would be of little empirical significance in applied studies, other recent authors, including Mishan, have insisted on the necessity for theoretical precision. Willig established the usefulness of CS as an approximation to CV and EV measures of consumer welfare change under specified conditions. However, conditions under which PV and LV can be useful have not been rigorously developed. In this paper, guidelines are developed for using PV and LV as empirical approximations for theoretically preferable CV and EV measures. These guidelines require less information than those developed by Willig and PV and LV measures have several addi: tional advantages in applied research.

Utility maximization, demand systems and transport benefit evaluation

Recently Johnson has outlined the utility‐maximization approach to the estimation of transport demand functions. This note demonstrates how the use of such demand systems permits improvements to be made in the evaluation of the benefits of transport investments through the measurement of more satisfactory indices of consumer surplus than the Marshallian area under an ordinary demand curve. Section 2 outlines the alternative measures of consumer surplus and their relationship with demand curves in the case where only one price changes. In Section 3 we employ the theory of duality to show how the compensating variation and equivalent variation can be derived from utility‐based demand systems. The approach is illustrated using the linear expenditure system in Section 4, while Section 5 concludes with some comments on alternative utility‐based demand systems and the practicality of this approach to evaluation.

The Measurement of Deadweight Loss Revisited

modities (such as various consumer goods and labor), M fixed factors (such as land, natural resources and various types of fixed capital), and a government which taxes commodities and fixed factors in order to finance various govern- ment expenditures. It is well known2 that if the government can raise its required revenue by taxing the fixed factors alone, then the resulting allocation of resources is Pareto optimal-no single household's utility or real income can be increased without decreasing the utility of some other household. Suppose we are at an initial equilibrium where government revenue is being raised by taxing the fixed factors alone. Then the resulting equilibrium can be rationalized by maximizing a certain weighted sum of utility functions subject to various feasibility constraints. Now think of the government replacing the taxes on fixed factors with distortionary commodity taxes. In Section 3, we calculate the second order directional derivative of the above weighted sum of utility functions with respect to any feasible direction of tax change, evaluated at the initial equilibrium which is Pareto optimal. Of course, the first order directional derivatives of the weighted sum of utility functions with respect to feasible directions of tax change are zero evaluated at this initial equilibrium. We obtain a measure of economic due to tax distortions which is virtually identical to that of Boiteux (3, p. 113) and which bears a resemblance to the dead loss of Hotelling (22, p. 254), the consumer's surplus measures of Hicks (19; 20, pp. 330-3), and the deadweight loss measure of Harberger (16, p. 61; 17, p. 788). In Section 4, we calculate a measure of welfare based on Debreu's (4, 5) coefficient of resource utilization (which is a modification of a measure of due to Allais (1, 2)) and we show that under certain conditions, the Hotelling,

Estimating the benefits of recreation under conditions of congestion: Comments and extension

The purpose of this paper is to comment on and extend the analysis of a paper by Wetzel. He uses a commonly accepted model of demand for a congested recreational resource and shows how the Clawson method of estimating a recreational demand curve relates to it. Much of his analysis is useful but he errs in his interpretation of the proper value of consumer surplus. In this paper a specific formalization of the demand model is developed for the first time and it is used to show the correct measure of consumer surplus and how to specify the proper level of use for the congested resource.

Welfare effects on the United States of a significant multilateral tariff reduction

This paper summarizes an estimate of the impact of a 50 percent multilateral tariff reduction on U.S. trade, employment, capital utilization, and economic welfare. In addition to calculating conventional measures of consumer surplus and revenue effects, the paper quantifies the economic adjustment costs faced by labor and capital-owners who are displaced by trade liberalization. Account is taken of both direct and indirect effects through utilization of the 367- sector U.S. input-output table. Some of the more interesting and important welfare dislocation estimates are highlighted on an industry-by-industry basis. In the aggregate, the calculated gains from trade liberalization dwarf the measured adjustment costs by a ratio of almost 20 to 1.

An experiment on the economic value of visibility

This paper reports on the development and application of an iterative bidding technique to examine proposed visibility reductions in the Four Corners Region of the southwest United States. The iterative bidding technique is a method to elicit honest bids for “goods” not priced in formal markets. Four issues associated with direct revelation of preferences for environmental goods are explored: (1) the establishment of linkages between the physical parameters of visibility and representation of the “good” called visibility to individuals for valuation purposes; (2) a systematic test for both observed and induced biases associated with the interative bidding technique; (3) replication of the results of previous experiments; and (4) reporting of empirical divergences between compensating and equivalent surplus measures of consumer surplus.

Errata: An Empirical Transgression in "Consumer's Surplus Measures and the Evaluation of Resources"

Errata: An Empirical Transgression in "Consumer's Surplus Measures and the Evaluation of Resources"

The Net Social Benefits from a Research-Induced Cost-Reduction of an Energy Backstop Technology

Substantial effort has been devoted to the development of measures of benefit attributable to agricultural research that lowers commodity costs. With increasing scarcity of energy inputs, many research resources are being devoted to overcome this scarcity by reducing the costs of backstop technologies, i.e., nonexhaustible sources of energy output. Drawing from the theory of exhaustible resources and the literature of traditional surplus measures of benefit and cost, this paper develops a conceptual framework for quantifying the net social benefit for successful backstop cost-reducing energy research. 18 references.

Consumer's Surplus Measures and the Evaluation of Resources

A procedure for measuring option value and other preservation values of water quality is developed and applied to a case study area in the South Platte River Basin, Colorado. Benefits from water-based recreation activities are focus of the study. The ...