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1、Econ237MeasuringWelfareChange-MultiplePriceChangesInmanysituations,onewouldexpectapolicychangetoaffectseveralprices.Canwecalculatetheconsumersurplus(CS)ineachmarketandsumthechangestoobtainthetotalchangeinCS?Considerfigures1aand1b.Thefiguresdepictatwo-marketcase.In
2、bothfigures,thedemandcurvesaredrawnassumingthepriceoftheothergoodisconstantatitsinitiallevel.Thusthedemandcurveforgood1assumesthatthepriceofthesecondgoodremainsconstantatitsinitiallevelof$12.Incomealsostaysconstant.Infigure1a,ifthepriceofcommodity1fallsfrom$10to$8
3、,thechangeinconsumersurplusiscalculatedasareaA(i.e.,consumersgainareaA).Nowturntothesecondmarket.Here,considerapricereductionfrom$12to$7(recallthepriceofthegoodinmarket1hasalreadybeenchanged).Butthereisaproblem.Thereductioninthepriceofcommodity1willingeneralcausea
4、shiftinthedemandcurveforcommodity2.Sincewehavealreadyreducedthepriceofgood1,thecorrectprocedureistoevaluatetheCSinfmarket2usingtheD2curve.Thisdemandcurveisdrawnontheassumptionthatp1isheldconstantatitsnowlowerlevel($8).ThusthechangeinCSinmarket2isareaB+areaC.Themon
5、eymeasureoftheutilitygainofthecombinedfallinthetwoprices(consideringbothmarkets)isarea(A+B+C).Nowreversetheprocedure.Firstlowerthepriceofcommodity2,andthenthepriceofcommodity1.Then,areaBistheCSinmarket2,sincep1isnowheldconstantatitsinitiallevel($10).Inmarket1,ther
6、eductionofthepriceofcommodity2shiftsthedemandcurvetotheifrightfromD11toD.Thus,reducingp1from$10to$8,giventhatp2hasalreadybeendecreased,addsareaA+DtoCS.IntotalCS=A+D+B.WehaveobtainedtwodifferentCSmeasures.Ingeneral,thereisnoreasonthatweshouldexpectA+B+C=A+D+B.Thisi
7、sthecaseeventhoughbothmeasuresevaluatethesamechangeinprices(fromp1=10,p2=12top1=8,p2=7).Theorderinwhichthepricesarechanged,thepathofpricechanges,affectsthesizeofthemoneymeasures.Thisisknownasthepathdependencyproblem.Theimplicationisthatitisnotappropriatetousethear
8、eatotheleftofthedemandcurvetoevaluatemultiplepricechanges.Theonlywaytoavoidthisproblemistoknowtheutilityfunction,thenwecouldsimplyevaluatethewelfarechan
