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Economics: Measuring the Benefits of Consumption


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About this Lesson

  • Type: Video Tutorial
  • Length: 6:15
  • Media: Video/mp4
  • Use: Watch Online & Download
  • Access Period: Unrestricted
  • Download: MP4 (iPod compatible)
  • Size: 66 MB
  • Posted: 03/29/2010

This lesson is part of the following series:

Economics: Full Course (269 lessons, $198.00)
Economics: Evaluating Market Outcomes (15 lessons, $19.80)
Economics: Normative Economics (2 lessons, $2.97)

In this video lesson, we will learn how to measure the benefits of Consumption. Taught by Professor Tomlinson, this lesson was selected from a broader, comprehensive course, Economics. This course and others are available from Thinkwell, Inc. The full course can be found at The full course covers economic thinking, markets, consumer choice, household behavior, production, costs, perfect competition, market models, resource markets, market failures, market outcomes, macroeconomics, macroeconomic measurements, economic fluctuations, unemployment, inflation, the aggregate expenditures model, banking, spending, saving, investing, aggregate demand and aggregate supply model, monetary policy, fiscal policy, productivity and growth, and international examples.

Steven Tomlinson teaches economics at the Acton School of Business in Austin, Texas. He graduated with highest honors from the University of Oklahoma and earned a Ph.D. in economics at Stanford University. Prof. Tomlinson's academic awards include the prestigious Texas Excellence Teaching Award given by the University of Texas Alumni Association and being named "Outstanding Core Faculty in the MBA Program" several times. He has developed several instructional guides and computerized educational programs for economics.

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We're going to do some normative economics now. Normative economics, you'll remember, answers questions like, is this outcome good? Can it be improved? The question that we'll be asking at first is this question, how much value is created by the existence of a particular market? What is this market worth to society? Now, the question of value means measuring the benefits that come from an activity and comparing those benefits with the costs. Value is defined as the difference between the benefits and the costs of a particular activity. So whenever we look at the value created by a market, we'll be looking at the benefit created by the trades that occur in that market and comparing them with the costs that are created when those trades occur. Benefits and costs and value.
The first question that we'll need to answer is, how do we measure the benefits that come from trades? How do we measure the benefits that are created in a market? Let me propose this answer to the question. That the benefit that you get from buying something is equal to the maximum price you would have paid to have that good. The maximum price that a consumer would pay to have a particular good is called the reservation price for that consumer for that particular good. Suppose we're considering a good like bread, and you're hungry, and the maximum price that you would be willing to pay for a loaf of bread, rather than do without it, is $5.00. In that case, $5.00 is your reservation price for that loaf of bread. The question is this--is $5.00 a good measure of the benefit you derive from eating that loaf of bread? Is $5.00 really what that loaf of bread is worth to you and is worth it to society that you enjoy?
Now, let's break that question down into two parts. If your reservation price for a loaf of bread is $5.00, that is, that's the maximum price you would be willing to pay for that bread, does that $5.00 represent the benefit that you get from that bread? Well, suppose you're a poor person. That is, suppose you only have $5.00, but you're very, very hungry, and if you had more money, say, $10.00 or $20.00, you would pay all of it to get that loaf of bread. In that case, the $5.00 isn't telling us so much about how much benefit you get from the bread. It's telling us how much money you have in your pocket. If we gave you more, you'd be willing to pay more.
In this particular case we say that you are subject to wealth effects. Wealth effects means that your income influences how much you would be willing to pay for something, and this becomes a problem when we're talking about necessities like food. Surely you'd be willing to pay more for food rather than do without it. But you're not able to pay more, because your income is restricted. If there are wealth effects, then a person's reservation price is not a reliable measure of the benefit that he gets from consuming that good.
So if we want to make an equation between reservation price and benefit, we have to assume that there are no wealth effects. That is, this is not a situation where poverty is important, or poverty is having a big influence on what people are willing and able to pay.
The second concern that we have concerns the question of the social benefit of the bread. Sure, the bread may be worth $5.00 to you, but does it have extra value for some other people who aren't eating it? Maybe children that you're able to take care of when you feel stronger from eating the bread. Or to take another example besides bread, what about a flu shot? The flu shot may be worth $5.00 to you, but if you get a flu shot, then you're less likely to sneeze on me and give me the flu later. So there are other people who are affected by your choice. Your choice affects other people besides just you. There are not only the private benefits, but there are also what we call external benefits. Your consumption creates benefits for other people.
Now, when I go to get a flu shot I may not think about all of the other people that benefit from my health, and because of that, my willingness to pay for a flu shot is lower than the benefits than I'm creating for society as a whole. That is, my price--the price that I'm willing to pay, reflects my private benefits, not benefits that are created for others.
So if we want to make an equation between social benefit and reservation price, we're going to want to assume that we're dealing with a product that does not have a lot of external benefits. That is, a product whose benefits are confined to the person who buys it and uses it.
So a quick summary. Reservation price might be a good measure of social benefit. That is, the benefit that a good creates for society. But it will only be a good measure if two conditions are satisfied. First, there should be no wealth effects and second, there should be no external benefits.
Evaluating Market Outcomes
Normative Economics
Measuring the Benefits of Consumption Page [1 of 1]

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