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

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