Appendix to Chapter 5;

An analysis of consumer surplus as

a measure of consumer welfare
THE PURE CONSUMER CASE

Ordinal utility function U(q), q =(q1,,qN) where q is

vector of consumption quantity
Assumptions of utility function
Monotonically increasing (U/q > 0)
Quasi-concave: Non increasing marginal rate of
substitution OR indifference curve is nowhere concave to
origin
Twice differentiable in q: First and second derivative of q
exists
THE PURE CONSUMER CASE

Budget Constraint m=pq, p =(p1,,pN) where p

is vector of prices corresponding to q
pq =
pq= p1q1,,pNqN
Assumption of budget constraint
Non-negativity constraint on consumption q > 0
THE PURE CONSUMER CASE

Utility maximization maxq{U(q)| m=pq, q 0}

Solving through Lagrangian

L = U(q) + (m pq)
L/ q = Uq - p = 0

Samulson pointed out that Lagrangian multiplier is

the marginal utility of income
THE PURE CONSUMER CASE

Ordinary Demand Function

q = [q1~(p,m),qn~(p,m)] q~(p,m)
Substituting into Utility function
U U(q~(p,m)) V(p,m) V
~ = Marshallian Demand
V = Indirect utility function: It gives the consumers maximal
attainable utility when faced with goods, prices and income
THE PURE CONSUMER CASE
Change in Utility
U = V(p1,m1) V (po, mo)
= L dV = L [Vmdm + Vpdp]
= Integral (opposite to derivation)
Vpdp =
Vi= V/ pi & Vm= V/m
L= Some path of integration in price-income space from (p0,
mo) to (p1, m1)
V = dV = dU = Uqdq~ As Uq = p

Therefore, U= LUqdq~
THE PURE CONSUMER CASE

Change in Utility
By taking total differential of budget constraint m=pq
dm= p.dq + q~.dp
dm q~.dp = p.dq
The equation U= L pdq~ now becomes

This line integral gives an exact measure of utility change

regardless of path L
THE PURE CONSUMER CASE

Taking as Constant
As is unobservable therefore it is not possible to
convert utility change into monetary measures
Therefore assume approximately constant over the
path L and divide by to obtain money measure U/

U/ = L [dm q~.dp]/
THE PURE CONSUMER CASE

Roys Identity
In which case could be constant?
In case can possibly be constant or S is a unique solution,
then
U= U(q(p,m)=V(p,m)
As marginal utility of income is always positive Vm>0 then
inverse utility function is as under
m= V-1(p,U`)
By putting the value of m
U= V(p, V-1(p,U`))
THE PURE CONSUMER CASE

Roys Identity
U= V(p, V-1(p,U`))

Differentiating w.r.t. p yields

0 = Vp/ p + Vm .V-1/ p

0 = Vp + Vm .m/ p

0 = Vp + Vm q~

- Vp = Vmq~

- Vp/Vm = q~ As Vm=

Therefore Vp= - q~
THE PURE CONSUMER CASE

Roys Identity
Vp= - q~

Differentiating w.r.t. m yields

Vp/ m = (- q~)/ m

It is evident that can not be constant for all prices and income
because if p = 0 and m = 0 then qm should be equal to zero which
cannot be hold as per budget constraint implies that

1 = m/ m = pq/ m = pqm~
THE PURE CONSUMER CASE

Roys Identity

can be constant for all prices but not for income

can be constant w.r.t. income and N-1 prices (pN=1,

UN= )
PATH DEPENDECE OF CONSUMER SURPLUS

Silberberg considers changes in all prices but holds

income constant (dm=0)
S = L [dm q~.dp]
Becomes S = - L q~.dp
Relevant Path independence condition is
PATH DEPENDECE OF CONSUMER SURPLUS

Richter considers the price of one good, qN , fixed

(dpN=0) while all other prices and income may vary
S = L [dm q~.dp]
Relevant Path independence condition is
MONEY MEASURES OF UTILITY CHANGE

need to be constant only with respect to the

prices that change (and income if it changes)
between the initial and final states (much less
restrictive than those developed by
Samuelson, Silberberg, Richter)
MONEY MEASURES OF UTILITY CHANGE

A unique money measure of utility change can

be established under two conditions:
1. If qi/ pj = qj/pi for all pairs of prices
that change OR
2. If is constant with respect to the prices
that change (and income if it changes)
In case, a policy-maker seeks simply to
maximize the sum of the two consumers
utilities. This is not possible until and unless
their marginal utilities of income are identical
THANKS