Does an Increase in the Price of a Necessity Reduce Welfare More than an Equivalent Increase in the Price of a Luxury?

by Joseph P. Newhouse

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This paper develops an argument to suggest that the price increase that causes the greater decrease in welfare is independent of which good is a "necessity," if necessity is interpreted as low-income or low-price elasticity. A simple two-commodity model expresses utility as a function of medical care and a composite bundle of other goods. Conclusions that hold for the model are assumed to apply to a multicommodity world. An illustration shows the proportion of a city worker's family budget for a moderate living standard allocated to various commodities in 1966. According to this index, shelter, food, and medical care price increases cause a noticeably greater decrease in welfare than other commodity groups. Thus, there may be some reason for concern over recent behavior of medical care prices, but the reason is not that medical care is a "necessity." 8 pp.

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