Question

a) Graphically identify two alternative money measures of welfare for an imposed change in the level of an environmental service flow (S1 > S0).

b) Discuss the pros and cons of the measures you demonstrated above.

c) Distinguish between the compensating and equivalent measures using both expenditure and indirect utility function approaches. Explain the difference between the two in words.

Answer 1

Answer (a) :

Two alternative measure of welfare in a society can be identified as the GDP of the country and the Health index of the common people.

As we can see from the graph above, the GDP1 curve is the GDP of the last year and the curve GDP2 is the GDP of the current year. If, like as in the graph above, the GDP curve moves ahead, we can conclude that the GDP rate of the country has been positive and better than the last year.

                       Similarly, the H1 curve is the Health index of the last year and the curve H2 is the Health index of the current year. If, like as in the graph above, the Health index curve moves below, we can conclude that the Health index rate of the country has been negative and poorer than the last year.

Answer (b) : The positives of the measures demonstrated are many , like, the GDP is the figure that is the final index of the overall development of an economy. If GDP is positive, it would imply that economy has actually overall performed better. Moreover, GDP shows us the overall position of a country’s development in perspective with other countries, which helps the economy to perform better by rectifying the ill economic happenings. Similarly, the Health index of a nation shows us, how well the people of a country stay. If the country has a positive health index, the country is improving in its health sector and lesser citizens are prone to ill health.

However, the GDP measures the overall development of an economy. It can never calculate the economic condition of the poorer section of the society, as GDP even shows increasing when the condition of the poor remain the same or even worsen off. This is because, GDP never measures the mental utility of social utility if a nation. Similarly, the Health sector only calculates the health index out of the total reported cases in the medical centers. Those cases, which have never been reported are never brought under calculation.

Answer ( c) : Compensating variation refers to the change in a consumers utility that needs to be reverted back to reach back to a point of the consumers initial utility. The variance to reach back to the original state of utility is called compensating measures. Adjustments made in the expenditure to reach up to the new utility can be easily reverted back by paying back off the expenditure made by the consumer, so that he goes back to the original state of utility. However, the indirect utilities cannot be physically measured.

Whereas, equivalent variation of measure relates to the change in the consumers overall satisfaction due to an increase in the consumers price level. If a consumer receives a higher pay out and hence his utility rises, this is referred to as an equivalent measure. In this type of measure, the measurement of the customers utility is easier , as here the base of the utility change is price and can easily be reverted if the need be.