Slutsky Equation
64
Slutsky Equation
A. We want a way to decompose the effect of a price
change into ‘‘simpler’’ pieces.
1. that’s what
analysis
is all about
2. break up into simple pieces to determine behavior
of whole
x
m/p
m'/p
X
Y
Z
x
Substitution
effect
Income
effect
Shift
Pivot
Indifference curves
2
2
2
1
Figure 8.2
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65
1. these are hypothetical changes
2. we can examine each change in isolation and look
at sum of two changes
C. Change in demand due to pivot is the
substitution
effect
.
1. this measures how demand changes when we
change prices, keeping purchasing power fixed
2. how much would a person demand if he had just
enough money to consume the original bundle?
3. this isolates the pure effect from changing the
relative prices
4. substitution effect
must
be negative due to revealed
preference.
a) ‘‘negative’’ means quantity moves opposite the
direction of price
D. Change in demand due to shift is the
income effect
.
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 Spring '08
 Johnson
 Slutsky Equation, Slutsky

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