Article
On the need to compensate the compensating variation
Economic Systems Research
(2018)
Abstract
The message of this research is that in the standard calibrated set-
ting of Computational General Equilibrium (CGE) models, the welfare
measures typically used to compare benchmark with counterfactuals
are numéraire dependent. This evaluation bias affects the compen-
sating variation and the Konüs index of cost of living. We show
that the equivalent variation is neutral regarding the choice of value
units in calibrated models but would be affected as well in uncali-
brated CGE models. We illustrate with a simple example and propose
an even simpler theoretical solution to overcome these biases; all
that is required to have correct welfare estimates is to compensate
normalizing with a suitable price index. This type of correction is nec-
essary to overcome the sometimes blind implementation of welfare
measures in numerical general equilibrium analysis. We show that
the induced quantitative errors may be substantial providing biased
welfare estimates and misleading results.
Keywords
- Compensating variation; equivalent variation; computable general equilibrium
Disciplines
Publication Date
September, 2018
DOI
http://dx.doi.org/10.1080/09535314.2017.1372371
Citation Information
Ana-Isabel Guerra and Ferran Sancho. "On the need to compensate the compensating variation" Economic Systems Research Vol. 30 Iss. 3 (2018) p. 313 - 322 Available at: http://works.bepress.com/ferran_sancho/68/