Buying and Selling - Economics 21 Intermediate Microeconomics Topic 2 Consumer Theory Buying and Selling Economics 21 Intermediate Microeconomics Topic

Economics 21: Intermediate Microeconomics Topic 2: Consumer Theory - Buying and Selling 1 Economics 21: Intermediate Microeconomics Topic 2: Consumer Theory Buying and Selling Reference: Varian, Chapter 9 Outline: I. Introduction II. Slutsky Equation Revisited I. Introduction We have seen how the Slutsky equation can be used to decompose the effect of a price change into an income and a substitution effect. In particular, the Slutsky Equation showed that if money income is held constant, and the good is normal, then a reduction in its price must lead to an increase in demand. Money income, however, does not generally remain constant. In particular, if a consumer has an in initial endowment, ! 1 of good 1, than a fall in the price of good 1 will lead to a fall in the consumer’s income. In the more general case where we allow the consumer to buy and sell, there are essentially two income effects: First, there is the ordinary income effect measures the increase in purchasing power resulting from a price change – i.e. when a price falls,