Definition of Compensating and Equivalent Variation for an Increase in the Price of One Good
Compensating Variation : Suppose that the price of X increases. How much income is required to compensate the individual for the price increase?
By “compensate” , we mean the income increase required for the individual to obtain the same well-being at the higher price as at the initial lower price.
Equivalent Variation: Suppose that the price of good X increases. What income reduction would affect the individual in an equivalent way?
By “equivalent”, we mean what reduction in income, with no change in prices would have an equivalent affect upon the individual’s well-being?
Definition of Compensating and Equivalent Variation
(for the increase in the price of one good or for any other changes in the prices of the goods)
:
Compensating Variation : Suppose that some prices change. How much income is required to compensate the individual for the price change?
By “compensate” , we mean the change in income required for the individual to obtain the same well-being at the new as at the initial prices.
Equivalent Variation: Suppose that some prices change. What income change would affect the individual in an equivalent way?
By “equivalent”, we mean what reduction in income, with no change in prices would have an equivalent affect upon the individual’s well-being?

Initially I=$32, the price of X is $1 and the price of Y is $4.
Compensating Variation
Y 10
9
8
7
6
5
4
3
2 BL-LP
1
BL-HP
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
X
Equivalent Variation
Y 10
9
8
7
6
5
4
3
2
1
BL-HP
BL-LP
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
X

.
The steep BL that is farther from the origin is the hypothetical BL that we use in determining CV.
Y 10
The flat BL that is closer to the origin is the hypothetical BL that we use in determining EV.
Y 10
9 9
5
4
3
2
8
7
6
BL-LP
1
BL-HP
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
X
8
7
6
5
4
3
2
1
BL-HP
BL-LP
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
X

Y
10
9
8
7
6
CC
C2
C1 is the optimum at the initial price of good X
C2 is the optimum at the higher price of good X
CC is the optimum for the BL used in finding CV
CE is the optimum for the BL used in finding EV
C1
5
4
3
2
CE
BL:LP
1
BL-HP
BL-EV
BL:CV
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
X