The concept of compensating variation means:
A)the change in income necessary to hold the consumer at the final level of utility as price changes.
B)the change in income necessary to restore the consumer to the initial level of utility as price changes.
C)the income effect.
D)the substitution effect.

Question

Quizplus · Accepted Answer

Compensating variation refers to the amount of money necessary to return the consumer to their initial level of utility. In other words, it is the amount of additional income that would be needed to restore the consumer's purchasing power to what it was before a price change occurred. Therefore, choice (B) is the correct answer. Choice (A) refers to equivalent variation, which is the change in income necessary to keep utility levels constant as prices change. The income effect and substitution effect (choices C and D) are related to the change in demand that occurs as a result of a price change, but they do not relate specifically to compensating variation. Compensating variation refers to the amount of income that a consumer would need to be given (compensated) in order to return to their original level of utility after a price change. This is different from the concept of equivalent variation, which refers to the amount of income that a consumer would be willing to give up (equivalent) in order to maintain their current level of utility after a price change.

The Concept of Compensating Variation Means