Slutsky Equation Microeconomics Pdf

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–Increases demand for xbyIncome Effect –Agent’s income falls by x*×∆p–Reduces demand byp p h ' w w* *p m x x ' w w – Slutsky Equation – Giffen Goods – Price Elasticity of Demand Spring Econ LectureSubstitutes and Complements We will now examine the effect of a change in the price of another good on demand. The sum of these two effects is called the The income eff ect results from an increase or rease in the consumer’s real income or purchasing power as a result of the price change. Since both the substitution and income effects increase demand when own-price falls, a normal good’s ordinary demand curve slopes down Slutsky Equation Suppose pincrease by ∆pSubstitution Effect. demand increases with income). Slutsky’s omposition of the effect of a price change into a pure substitution effect and an income effect thus explains why the – Slutsky Equation – Giffen Goods – Price Elasticity of Demand Spring Econ LectureSubstitutes and Complements We will now examine the effect of a change Slutsky’s Effects for Normal Goods Most goods are normal (i.e. –Holding utility constant, relative prices change. SLUTSKY’S EFFECT FOR GIFFEN GOODS. = x 1(p 1, m) − x 1(p 1, m ) So returning to our example, the income effect is the remaining change in demand, once we’ve accounted for the substitution effect: Δx The substitution effect involves the substitution of good x1 for good x2 or vice-versa due to a change in relative prices of the two goods. Define xand xas “Gross Substitutes” if an increase in the price of xleads to an increase in the demand for x 1 n Δx. is the change in demand for goodwhen we change income from m’ to m, holding the price of goodfixed at the new price p1’. What happens Goodis normal because higher income increases’’’. Slutsky’s Effects for Normal Goods. demand, so the income and substitution (x 1’’’,x 2’’’) effects reinforce each other. When the price of a good changes, there are two sorts of e®ects: the rate at which you can exchange on good for another changes, an the total • The Slutsky Equation omposes the total change in demand caused by a change in prices into two pieces, the Substitution effect and the Income effect. Δx. n. The substitution and income effects reinforce each other when a normal Slutsky Equation.