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Lecture 7 _Hicksian Demand and Slutsky Equation_

# Lecture 7 _Hicksian Demand and Slutsky Equation_ - Hicksian...

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Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation Hicksian Demand and Slutsky Equation (Lecture 7) Nicholson (2007), Chapter 5 January 24, 2011 George Georgiou - Intermediate Microeconomics 1/19

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Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation Compensated (Hicksian) Demand The above presentation is the standard way to talk about demand, but it is not the only one . As we saw in the previous picture, utility changes along the demand curve. We move to higher IC as the price goes down. The reason for this is that under construction, the demand curve holds nominal income constant. So, what if we had a demand curve along which utility stays constant ? Now, this is our task. George Georgiou - Intermediate Microeconomics 2/19
Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation Compensated (Hicksian) Demand This alternative demand is called Compensated or Hicksian demand . Here we maintain utility constant at the level of a certain IC as we gradually decrease the price of good 1. As p 1 goes down, at the same time we reduce the nominal income of our consumer so that we exclude the possibility of any increase in utility and make sure that our consumer stays on the same IC . In other words, the potential impact on purchasing power of the decrease in p 1 is compensated by a decrease in nominal incom e so that real income (purchasing power) stays constant! Therefore, the reaction of the quantity demanded to the decrease of p 1 will be only due to the substitution effect since the income effect has been neutralized. George Georgiou - Intermediate Microeconomics 3/19

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Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation Compensated (Hicksian) Demand As you may gather, in case of an increase in p 1 , we compensate our consumer by increasing his nominal income so that they stay on the same IC. The compensated demand curve depicts the relationship between the price of a good and the quantity demanded of this good, under the assupmtion that all other prices and utility are kept constant . Therefore, this curve shows only the substitution effect. We write: x 1 = x c 1 ( p 1 , p 2 , u ) George Georgiou - Intermediate Microeconomics 4/19
Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation Price of good 1 decreases and the Hicksian Demand George Georgiou - Intermediate Microeconomics 5/19

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Hicksian Demand and Slutsky Equation (Lecture 7) Hicksian Demand Expenditutes Minimization Slutsky Equation
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