10 - Hicks - Slutsky Decomposition Change in demand due to...

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1 Slutsky Decomposition ± Change in demand due to pivot is the substitution effect (A to B) ± this measures how demand changes when we change prices, keeping purchasing power fixed x 2 x 1 A x 1 ’’ x 2 ’’= C B x 2 x 1 ± Change in demand due to shift is the income effect. (B to C) x 2 x 1 ω 1 ω 2 Backward Bending Supply New budget line C Rise in P 1 may reduce net supply of X 1 Old budget line X 1 A X 2 ω final budget line C I S B S S If the price of apples (good 1) goes up, a seller experiences a real income gain. If he consumes more himself as a result, he supplies less. initial budget line X 1 A X 2 endowment ω Backward Bending Supply
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2 Net supply of good 1 never bends back where good 1 is (locally) inferior If net supply of good 1 does bend back, then good 1 is (locally) normal Backward Bending Supply What is Meant by Unchanged “Real Income”? According to Slutsky: Real income doesn’t change if, at the new prices, you can just afford to purchase the bundle which
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This note was uploaded on 04/02/2008 for the course ECON 401 taught by Professor Kuhn during the Fall '08 term at University of Michigan.

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10 - Hicks - Slutsky Decomposition Change in demand due to...

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