This preview shows page 1. Sign up to view the full content.
Unformatted text preview: Xnew = 1 + 0.1m - 0.3(px+0.1) + ε. Now
Xnew – X = -0.3*0.1, so you consume 0.03 less apples. The intuition is that for each dollar
increase in the price of apples, you consume 0.3 less apples, but since the price only rose
by ten cents instead of a dollar, you consume 0.03 less apples. Hence demand for apples
is not perfectly elastic. You can also see this by differentiating X wrt Px and multiplying
the result by 0.1.
c) We know that when the price of apples increases by 10 cents, demand for apples falls
by 0.3*.1 = .03 apples. But the important thing to note is that this 0.03 decrease is the
combined income and substitution effects. The Slutsky equation is that the substitution
effect S = ∂X/∂px + (∂X/∂m)*X, where the term S is the substitution effect, ∂X/∂px is the
total effect, and (∂X/∂m)*X is the income effect. When the price increase by 1, we have
S = -0.3+0.1*2 = -0.1, where -0.3 is t...
View Full Document
This note was uploaded on 02/09/2014 for the course ECON 1130 taught by Professor Baum-snow during the Spring '11 term at Brown.
- Spring '11