equivalent variation

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The amount of additional income needed to give the level of utility which an individual could have reached if the economic environment had changed. For example, if a price of a good demanded by a consumer were to fall the consumer would be better off. The equivalent variation of this price fall is therefore positive: the consumer would need to be given additional income to make them as well off without the price fall as they would have been with the price fall. Using the expenditure function, E(p,U), the equivalent variation, EV, is defined byEV = E(p1,U1)− E(p0,U1)where p0 denotes initial prices, p1 final prices, and U1 final utility. The equivalent variation of a price rise is positive, and the equivalent variation of a price fall is negative. This is an alternative to the compensating variation, which is the amount of additional income needed to restore an individual's original level of utility if the price of any good consumed changes.

EV = E(p1,U1)− E(p0,U1)

Subjects: Economics.

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