Consumer Surplus, Demand Functions, and Policy Analysis

by Frank Camm

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This report explains how demand functions can be used properly to measure policy-induced changes in consumer surplus. For the most part, it brings together existing results from the economics literature and presents them in a common, systematic framework. Its goal is to provide the practicing policy analyst with a rigorous and intuitive understanding of the most common measures of consumer surplus used today. Section II develops the concept of consumer surplus at the level of the individual and contrasts the concepts associated with Hicks, Marshall, and Harberger. Section III explains how these concepts are related to different kinds of demand curves and to areas to the left of policy-induced consumption loci. Section IV discusses how to aggregate measures of consumer surplus across individuals and integrates the notion of consumer surplus with more general concerns about how policies affect social welfare. Section V closes the report with some notes on how to choose a measure of consumer surplus for a particular policy problem.

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