Tsinghua Micro Ch8 021011

# Tsinghua Micro Ch8 021011 - Chapter Eight Slutsky Equation...

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Chapter Eight Slutsky Equation

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What Are We Doing in this Chapter? We take a further look at the comparative statics of demand function with respect to prices; We divide the changes in demand due to price changes into two effects: Substitution effect; Income effect? Why? Deeper economic intuition.
Effects of a Price Change What happens when a commodity’s price decreases? Substitution effect : the commodity is relatively cheaper, so consumers substitute it for now relatively more expensive other commodities.

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Effects of a Price Change Income effect : the consumer’s budget of \$y can purchase more than before, as if the consumer’s income rose, with consequent income effects on quantities demanded.
Effects of a Price Change x 1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is \$y. x 2 y p 2

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Effects of a Price Change x 1 Lower price for commodity 1 pivots the constraint outwards. Consumer’s budget is \$y. x 2 y p 2 y p ' 2 Now only \$y’ are needed to buy the original bundle at the new prices, as if the consumer’s income has increased by \$y - \$y’.
The Idea behind the Slutsky Equation Divide the total changes to demand from a price change into 1) pure substitution effect; 2) an income effect.

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Pure Substitution Effect “What is the change in demand when the consumer’s income is adjusted
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## This note was uploaded on 12/06/2011 for the course BUSINESS MicroEco taught by Professor Luyu during the Spring '11 term at Tsinghua University.

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Tsinghua Micro Ch8 021011 - Chapter Eight Slutsky Equation...

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