Slutsky_slides

# Slutsky_slides - Consumer Theory Slutsky Eect University of...

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University of California, Santa Cruz January 2010

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Introduction When the price of good changes, there are two e/ects: The rate at which you exchange one good for another changes. The total purchasing power of your income also changes. When good 1 becomes cheaper, you have to give up less of good 2 in order to purchase good 1. Good 1 has become relatively cheaper in terms of good 2. When price of good 1 drops, your purchasing power has gone up. That is you can now purchase more of good 1, with the amount of income you have.
Substitution and Income E/ect Substitution e/ect : The change in demand due to the change in the rate of exchange between the two goods. Under the substitution e/ect, the consumer will always purchase more of the relatively lower-priced good. Substitute away from the relatively more expensive good. Income e/ect : The change in demand due to having more purchasing power. It is basically the change in consumption resulting from a change in real income. As long as the prices are constant, the change in income will create a parallel shift of the budget constraint. A " in income will cause the budget line to shift to the right (away from the origin) and a # in income will cause the budget to shift left (towards the origin). Total change in demand is calculated by combining the substitution e/ect and income e/ect.

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constant First let us review the basics of graph-making. Increase in price of good x while keeping income constant. Original budget constraint: m = p x x + p y y New budget constraint: m = p 0 x x + p y y , where p 0 x > p x x y Budget line (original) Budget line (new)
The Income e/ect Income e/ect: Increase in income ( m

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Slutsky_slides - Consumer Theory Slutsky Eect University of...

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