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Compensating the Compensating Variation

Author

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  • Ana-Isabel Guerra
  • Ferran Sancho

Abstract

The message of this note is that in a general equilibrium setting the compensating variation is numéraire dependent. In contrast, the equivalent variation is neutral regarding the choice of value units. We illustrate with a simple example and propose an even simpler solution to overcome this bias in the compensating variation; all that is required to have a correct welfare estimate is to compensate the compensating variation by normalization with a price index. This type of correction is necessary to overcome the often blind implementation of welfare measures in numerical general equilibrium.

Suggested Citation

  • Ana-Isabel Guerra & Ferran Sancho, 2017. "Compensating the Compensating Variation," UFAE and IAE Working Papers 961.17, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    • Handle: RePEc:aub:autbar:961.17
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    File URL: http://pareto.uab.es/wp/2017/96117.pdf
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    References listed on IDEAS

    as
    1. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680.
    2. Willig, Robert D, 1976. "Consumer's Surplus without Apology," American Economic Review, American Economic Association, vol. 66(4), pages 589-597, September.
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    Cited by:

    1. Ana-Isabel Guerra & Ferran Sancho & Antonio Manresa, 2017. "Measuring the true index of cost of living under general equilibrium," UFAE and IAE Working Papers 962.17, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    2. Guerra, Ana-Isabel & Manresa, Antonio & Sancho, Ferran, 2018. "The true index of cost of living under general equilibrium: The numéraire matters," Economics Letters, Elsevier, vol. 173(C), pages 69-72.

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    More about this item

    Keywords

    Compensating variation; equivalent variation; Konüs index; computable general equilibrium.;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D60 - Microeconomics - - Welfare Economics - - - General

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