Unformatted text preview: variable. Set utility equal to your original utility level (before the price change) and solve for your variable. 5. Go back to your equation from step 2 to solve for the other variable. These values give you the decomposition bundle. 6. The substitution e±ect is given by the change from your original bundle to this decomposition bundle. 7. The income e±ect is given by the change from the decomposition bundle to the ﬁnal bundle. 8. The ﬁnal bundle is found by ﬁnding the optimal bundle for the new prices (see above) and the new budget constraint equation. Remember: the substitution e±ect is always negative for a price increase (since relative price and quantity are negatively related). The direction of the income e±ect depends on whether the product is a normal or inferior good (with more money, are you going to buy more or less of the good). 1...
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 Spring '08
 Woroch
 Economics, Utility, Department of Economics University of California, Ana Rocca, decomposition bundle

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