The Slutsky method

Slutsky claimed that if, at the new prices, less income is needed to buy the original bundle then “real income” has increased and more income is needed to buy the original bundle then “real income” has decreased.

Slutsky isolated the change in demand due only to the change in relative prices by asking “What is the change in demand when the consumer’s income is adjusted so that, at the new prices, s/he can just afford to buy the original bundle?”

To isolate the substitution effect we adjust the consumer’s money income so that s/he change can just afford the original consumption bundle. In other words we are holding purchasing power constant.

Draw a line parallel to the new budget line which passes through the point Ea. The new optimum on I3 is at Ec. The movement from Ea to Ec is the substitution effect.

The remainder of the total price effect is the Income Effect. The movement from Ec to Eb.

Дата добавления: 2014-01-11