Suppose you work for a government agency that is considering removing

Suppose you work for a government agency that is considering removing certain agricultural subsidies. The removal of these subsidies will increase the price, thus lowering consumers’ welfare.

Because only aggregate market data is available, you are unable to measure the exact values for the compensated and equivalent variation by consumer. However, you are able to estimate the change in market consumer surplus. Assuming agricultural products are normal goods, how does your estimate of consumer surplus compare to the unknown EV and CV? Explain. Under what conditions will the three measures of welfare be close to one another?

ANSWER

For normal goods, the CS will be less than the CV and greater than the EV (in absolute value). Typically, these measures will be close for (1 ) small price changes, (2 ) small income effects/elasticity, and (3 ) small budget share.