Lecture_3_tab - Effects of a Price Change What happens when a commoditys price decreases Substitution effect the commodity is relatively cheaper so

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ECOS2001 Lecture 3 1 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. 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. Slutsky discovered that changes to demand from a price change are always the sum of a pure substitution effect and an income effect.
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ECOS2001 Lecture 3 2
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ECOS2001 Lecture 3 3 Effects of a Price Change x 1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is $y. x 2 y p 2
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ECOS2001 Lecture 3 4
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ECOS2001 Lecture 3 5 Effects of a Price Change x 1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is $y. x 2 y p 2 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’. BC1 BC2
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ECOS2001 Lecture 3 6
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ECOS2001 Lecture 3 7 Effects of a Price Change Changes to quantities demanded due to this ‘extra’ income are the income effect of the price change.
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ECOS2001 Lecture 3 8
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ECOS2001 Lecture 3 9 Pure Substitution Effect 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, she can only just buy the original bundle?”
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ECOS2001 Lecture 3 10
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ECOS2001 Lecture 3 11 Pure Substitution Effect Only x 2 x 1 x 2 x 1
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ECOS2001 Lecture 3 13 Pure Substitution Effect Only x 2 x 1 x 2 x 1
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ECOS2001 Lecture 3 14
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15 Pure Substitution Effect Only x 2 x 1 x 2 x 2 ’’ x 1 x 1 ’’ Lower p1 makes good 1 relatively cheaper and causes a substitution from good 2 to good 1. (x1’,x2’)
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This note was uploaded on 02/16/2010 for the course ECOS Economics taught by Professor None during the One '09 term at University of Sydney.

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Lecture_3_tab - Effects of a Price Change What happens when a commoditys price decreases Substitution effect the commodity is relatively cheaper so

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