1) Explain very carefully the role of the cost minimization problem in developing exact welfare measures. In your answer, first explain why the welfare measure given by the change in a consumer’s indirect utility function is not very useful when it comes to evaluating the merits
of a policy change. Then sketch the path from the cost minimization problem to the accurate money measures of a change in consumer welfare due to policy changes.
(2) Explain very carefully the role of the expenditure minimization problem in developing restrictions on the Marshallian demand that can be empirically tested. In your answer sketch the path from the expenditure minimization problem to these restrictions on the Marshallian
demand.
Sample Solution
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