Compensating variation

In economics, compensating variation (CV) is a measure of utility change introduced by John Hicks (1939). 'Compensating variation' refers to the amount of additional money an agent would need to reach its initial utility after a change in prices, or a change in product quality, or the introduction of new products. Compensating variation can be used to find the effect of a price change on an agent's net welfare. CV reflects new prices and the old utility level. It is often written using an expenditure function, e(p,u):

where ${\displaystyle w}$ is the wealth level, ${\displaystyle p_{0}}$ and ${\displaystyle p_{1}}$ are the old and new prices respectively, and ${\displaystyle u_{0}}$ and ${\displaystyle u_{1}}$ are the old and new utility levels respectively. The first equation can be interpreted as saying that, under the new price regime, the consumer would accept CV in exchange for allowing the change to occur.

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