ECON 2300 : AP ECON 2300 F2012 Session 5.doc
4 Dec 2013
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Substitution effect: the commodity is relatively cheaper, so consumers substitute it for now relatively more expensive other commodities. Income effect: the consumer"s budget of can purchase more than before, as if the consumer"s income rose, with consequent income effects on quantities demanded. x2. Lower price for commodity 1 pivots the constraint outwards. Now only " are needed to buy the original bundle at the new prices, as if the consumer"s income has increased by - ". Real income changes: slutsky asserted that if, at the new prices, less income is needed to buy the original bundle then real income is increased. More income is needed to buy the original bundle then real income is decreased. Lower p1 makes good 1 relatively cheaper and causes a substitution from good 2 to good 1. x2" x2"" (x1",x2") (x1"",x2"") is the pure substitution effect. x1" x1"". The income effect is (x1"",x2"") (x1""",x2"""). x2" x2"" (x1""",x2""") x1" x1"".
