Chapter Eight Slutsky Equation
Chapter Eight Slutsky Equation
What are We doing in this Chapter? We take a further look at the comparative statics of demand function with respect to prices; We divide the changes in demand due to price changes into two effects Substitution effect Income effect? Why Deeper economic intuition
What Are We Doing in this Chapter? We take a further look at the comparative statics of demand function with respect to prices; We divide the changes in demand due to price changes into two effects: –Substitution effect; – Income effect? Why? Deeper economic intuition
Effects of a Price Change What happens when a commodity's price decreases? Substitution effect: the commodity is relatively cheaper, so consumers substitute it for now relatively more expensive other commodities
Effects of a Price Change What happens when a commodity’s price decreases? –Substitution effect: the commodity is relatively cheaper, so consumers substitute it for now relatively more expensive other commodities
Effects of a Price Change Income effect: the consumers budget of Sy can purchase more than before, as if the consumers income rose, with consequent income effects on quantities demanded
Effects of a Price Change – Income effect: the consumer’s budget of $y can purchase more than before, as if the consumer’s income rose, with consequent income effects on quantities demanded
Effects of a Price Change Consumer's budget is Sy Lower price for commodity 1 y pivots the constraint outwards p2
Effects of a Price Change x1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is $y. x2 y p2
Effects of a Price Change Consumer's budget is Sy Lower price for commodity 1 y pivots the constraint outwards p2 Now only Sy'are needed to buy the y original bundle at the new prices, p2 as if the consumers income has increased by Sy -y
Effects of a Price Change x1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is $y. x2 y p2 y p ' 2 Now only $y’ are needed to buy the original bundle at the new prices, as if the consumer’s income has increased by $y - $y’
The Idea behind the Slutsky equation Divide the total changes to demand from a price change into 1)pure substitution effect; 2) an income effect
The Idea behind the Slutsky Equation Divide the total changes to demand from a price change into 1) pure substitution effect; 2) an income effect
Pure Substitution effect What is the change in demand when the consumers income is adjusted so that, at the new prices, she can only just buy the original bundle?” Le, changes in demand without changes in real income
Pure Substitution Effect “What is the change in demand when the consumer’s income is adjusted so that, at the new prices, she can only just buy the original bundle?” I.e., changes in demand without changes in real income
Pure Substitution Effect Only
Pure Substitution Effect Only x2 x1 x2 ’ x1 ’
Pure Substitution Effect Only
Pure Substitution Effect Only x2 x1 x2 ’ x2 ’’ x1 ’ x1 ’’