Substitution Principle

Substitution Principle - position of Mux = 8, Px = 4, Muy =...

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Substitution Principle: The law of equimarginal utility as the basis of consumer equilibrium can be extended to cover any number of goods. In its general form, the law can be stated as This law is also known as the principle of substitution . In order to maximize satisfaction the law requires the substitution of units of one good in place of the other so long as the ratio is not brought into equality. This can be illustrated with the help of two goods. Let us begin with an initial equilibrium
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Unformatted text preview: position of Mux = 8, Px = 4, Muy = 12 and Py = 6, If the price of X falls to $2 and the price of Y is constant then, Therefore the Mu/P ratio for good X whose price has fallen is now greater than the similar ratio for good Y whose price has not fallen. According to the rule, there will be an increase in the consumption of the cheaper good (X) and a decrease in the consumption of the dearer good (Y)....
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