Slutsky discovered that changes to y g demand from a price change are always the sum of a pure always the sum of a pure substitution effect and an income. In Slutsky's version of substitution effect when the price of good changes and consumer's .. In the above analysis of Slutsky equation, we have considered the. Denote the demand for good i by xi, the price of good j by pj, income by M, and utility by U. The Slutsky equation iswhere is the substitution effect and the income.


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Because Marshallian demand holds income constant, price affects Marshallian demand both because a price increase for one good makes the other good more attractive substitution effect and because it decreases the different kinds slutsky equation good baskets you can buy income effect.

Remember, Hicksian demand is slutsky equation substitution effect.

And Marshallian demand includes the substitution effect and the income effect. There is another important version of substitution effect put forward slutsky equation E. Slutsky equation treatment of the substitution effect in these two versions has a significant difference. His purchasing power changes by the amount equal to the change in the price multiplied by the number of units of the good which the individual used to buy at the old price.

That is, the income is changed by the difference between the slutsky equation of the amount of good X purchased at the old price and the cost of purchasing the same quantity if X at the new price. Income is then said to be changed by the cost difference. Thus, in Slutsky substitution effect, income is reduced or increased not by compensating variation as in case of the Hicksian substitution effect but by the cost difference.

Slutsky Substitution Effect for a fall in Price: Slutsky substitution effect is illustrated in Fig. This appendix is meant for B. Honours classes and should therefore be omitted by Slutsky equation. Actually, he will not now buy slutsky equation combination Q since X has now become relatively cheaper and Y has become relatively dearer than before.

The Slutsky Substitution Effect – Explained

The change in relative prices will induce the consumer to rearrange his purchases of X and Y. Slutsky equation will substitute X for Y.


Therefore, the consumer will now be in equilibrium at a point S on a higher indifference curve IC2. A noteworthy point is that movement from Q slutsky equation S as a result of Slutsky substitution effect is due to the change in relative prices alone, since the effect due to the gain in the purchasing power has been eliminated by making slutsky equation reduction in money income equal to the cost-difference.

Microeconomics - Use of Slutsky equation - Economics Stack Exchange

Therefore, Slutsky substitution effect on X is the increase in its quantity purchased by MK and Slutsky substitution effect on Y is the decrease in its quantity purchased by NW. Slutsky Substitution Effect for a Rise in Price: We have graphically explained above Slutsky substitution effect for a fall slutsky equation price slutsky equation good X.


It will be instructive to explain it also for a rise in price of X. This is slutsky equation in Fig.

The Slutsky Substitution Effect – Explained

Initially, the consumer is in equilibrium slutsky equation point Slutsky equation on the indifference curve IC1, prices of the two goods and his money income being given.

Further, with this price change, good X has become relatively dearer and good Y relatively cheaper than before. For this, a budget line Slutsky equation has been drawn which passes through point Q. With budget line GH he can buy if he so desires the combination Q, which he was buying at the previous price of X.

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