Consumer's Surplus Without Apology

Abstract

The purpose of this paper is to settle the controversy surrounding consumer's surplus' and, by so doing, to validate its use as a tool of welfare economics. I will show that observed consumer's surplus can be rigorously utilized to estimate the unobservable compensating and equivalent variations-the correct theoretical measures of the welfare impact of changes in prices and income on an individual. I derive precise upper and lower bounds on the percentage errors of approximating the compensating and equivalent variations with consumer's surplus. These bounds can be explicitly calculated from observable demand data, and it is clear that in most applications the error of approximation will be very small. In fact, the error will often be overshadowed by the errors involved in estimating the demand curve. The results in no way depend upon arguments about the constancy of the marginal utility of income. Consequently, this paper supplies specific empirical criteria which can replace the apologetic caveats frequently employed by those who presently apply consumer's surplus. Moreover, the results imply that consumer's surplus is usually a very good approximation to the appropriate welfare measures. To preview, below I establish the validity of these rules of thumb: For a

The authors' abstract, as published at the source. American Economic Review, 2016 · DOI ↗