Lecture 10 handout - Substitutes Complements and Slutsky Equation

Lecture 10 handout - Substitutes Complements and Slutsky Equation

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Substitutes and Complements Two goods are substitutes if each separately ful fi lls the same desired purpose. The more substitutable are two goods, the closer to linear are the indi ff erence curves. That is, the MRS does not change much as you move along the indif- ference curve. (The extreme case is perfect substitutes.) Two goods are complements if they jointly ful fi ll a single desired purpose. The more complementary are two goods, the curvier the indi ff erence curves; intuitively, since the two goods jointly serve the same goal, mixing them is very advantageous. That is, the MRS diminishes rapidly as you move along the indi ff erence curve. (The extreme case is perfect complements.) The above de fi nitions are somewhat vague because di ff erent (precise) de fi n- itions are useful in di ff erent contexts. Here is one set of precise de fi nitions that is useful in the context of consumer demand: Good 1 is a gross substitute for Good 2 if 1  2 0 . Good 1 is a gross complement for Good 2 if 1  2 0 . 2 The Slutsky Equation Suppose a consumer with income and facing prices 1 and 2 has the (optimal) consumption bundle ( 1 2 ) . Now suppose the price of Good 1 increases from 1 to 0 1 . We can see graphically that such a price increase of Good 1 can either increase or decrease quantity demanded for Good 1. Slutsky’s insight is that we
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern