Indirect Welfare Effects of Price Changes and Cost-Benefit Analysis

The effects of a policy measure often reach the consumer only after one or more intermediate steps, for instance because the measure lowers the cost of an input for an industry producing a consumer good. This paper is concerned with the question how to measure such indirect effects correctly under conditions of perfect and imperfect competition. Conventional CBA measures the indirect effects on consumers as the direct effect on other actors (e.g. the Marshallian consumer’s surplus of the demand for the input whose price changes). Formal analysis establishes the correctness of this approach under perfect competition, provided that the demand curve is appropriately defined. Under less than perfect competition, the indirect effect can differ from the direct effect. Under monopoly the indirect effect is always larger than the direct effect. Under monopolistic competition it can be smaller, identical or larger, depending on the details of the model specification and on the possibility of entry. This research was financed partly by the Rijksluchtvaartdienst (Dutch Aviation Council) * Department of Spatial Economics, Free University, De Boelelaan 1105, 1018 HV Amsterdam, Netherlands, tel. 31-20-4446093, fax 31-20-4446004, e-mail: [email protected].