Compensating Variation (CV) vs. Equivalent Variation (EV)
In welfare economics, Compensating Variation (CV) and Equivalent Variation (EV) are standard money-metric measures used to evaluate the welfare effects of price changes. They are conceptually similar, but they differ in which utility level is held fixed and as a result ultimately yield different numerical values . 1) Compensating Variation (CV) Definition. Compensating Variation is the amount of money that must be given to (or taken from) a consumer after a price change so that the consumer can reach their original utility level . Formal expression (expenditure function). \( CV = E(p_{1}, u_{0}) - E(p_{1}, u_{1}) \) \( E(p, u) \): expenditure function (minimum expenditure to achieve utility \( u \) at prices \( p \)) \( p_{1} \): new price vector \( u_{1} \): new utility level \( u_{0} \): initial utility level Economic interpretation. Prices change first, and compensation is pro...