Chapter8 - Chapter 8 Slutsky Equation 1 We want a way to...

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Chapter 8 - Slutsky Equation 1. We want a way to decompose the effect of a price change into “simpler” pieces. (a) thats what analysis is all about (b) break up into simple pieces to determine behavior of whole 2. Break up price change into a pivot and a shift (see figure 8.2. in the textbook). (a) these are hypothetical changes (b) we can examine each change in isolation and look at sum of two changes 3. Change in demand due to pivot is the substitution effect . (a) this measures how demand changes when we change prices, keeping purchas- ing power of income fixed (b) how much would a person demand if he had just enough money to consume the original bundle? (c) this isolates the pure effect from changing the relative prices (d) substitution effect must be negative due to revealed preference “negative” means quantity moves opposite the direction of price 4. Change in demand due to shift is the income effect . (a) increase income, keep relative prices the same

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