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    Hicksian and Slutsky Condition

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    Andreea Stefan
    This document discusses Hicksian and Slutsky analysis for understanding how a change in the price of one good affects the demand for that good and for other goods. It provides 6 cases examining the substitution and income effects when the price of good X changes and X is a normal good, inferior good, or Giffen good. The Hicksian approach holds utility constant while the Slutsky approach holds purchasing power constant. In both approaches, the total price effect is the sum of the substitution and income effects, which can work in the same or opposite directions depending on whether the good is normal, inferior, or Giffen.

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    Hicksian and Slutsky Condition

    Uploaded by

    Andreea Stefan
    227 views23 pages
    This document discusses Hicksian and Slutsky analysis for understanding how a change in the price of one good affects the demand for that good and for other goods. It provides 6 cases examining the substitution and income effects when the price of good X changes and X is a normal good, inferior good, or Giffen good. The Hicksian approach holds utility constant while the Slutsky approach holds purchasing power constant. In both approaches, the total price effect is the sum of the substitution and income effects, which can work in the same or opposite directions depending on whether the good is normal, inferior, or Giffen.

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    Consumer Theory

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    This document discusses Hicksian and Slutsky analysis for understanding how a change in the price of one good affects the demand for that good and for other goods. It provides 6 cases examining the substitution and income effects when the price of good X changes and X is a normal good, inferior good, or Giffen good. The Hicksian approach holds utility constant while the Slutsky approach holds purchasing power constant. In both approaches, the total price effect is the sum of the substitution and income effects, which can work in the same or opposite directions depending on whether the good is normal, inferior, or Giffen.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    227 views23 pages

    Hicksian and Slutsky Condition

    Uploaded by

    Andreea Stefan
    This document discusses Hicksian and Slutsky analysis for understanding how a change in the price of one good affects the demand for that good and for other goods. It provides 6 cases examining the substitution and income effects when the price of good X changes and X is a normal good, inferior good, or Giffen good. The Hicksian approach holds utility constant while the Slutsky approach holds purchasing power constant. In both approaches, the total price effect is the sum of the substitution and income effects, which can work in the same or opposite directions depending on whether the good is normal, inferior, or Giffen.

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 23

    Hicksian and

    Slutsky
    Analysis

    Hicksian Analysis
    According to Hicksian effect, for change in price consumer
    first substitutes is consumption bundle (good x, good y)
    within same utility curve and after that income effect
    comes in where consumer shifts on higher indifference
    curve.

    Hence total Price effect is sum of Substitution effect and income


    effect
    PE = SE + IE
    Hence this analysis describes how price effect is partitioned.

    The benefit of this model is to see assuming utility constant, how


    does demand of good Y is changed if price of good X is
    changed.

    The mechanism is when price decreases then budget line


    rotates hence price ratio changes, so consumer first do
    substitution by parallel shifting of new budget line downward on
    old indifference curve. After this he jumps on new curve and line
    called as income effect.
    Substitution effect: Change in demand due to change in the rate
    of exchange (price ratio) between two goods keeping utility
    constant
    Income effect: Change in demand due to having more
    purchasing power
    Giffen goods must be inferior but not all inferior goods are
    Giffern goods. They are extreme inferior goods.
    Here we will perform 6 different cases
    1.
    2.
    3.
    4.
    5.
    6.

    Decrease in price of X when it is normal good


    Increase in price of X when it is normal good
    Decrease in price of X when it is inferior good
    Increase in price of X when it is inferior good
    Decrease in price of X when it is giffen good
    Increase in price of X when it is giffen good

    Case 1: Normal good,


    decrease price

    Decrease in Px

    I/Py

    E1

    E3

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is normal)

    E2
    IC2
    IC1
    X1

    X2

    SE

    I/Px
    IE

    PE

    X3

    I/Px

    Case 2: Normal good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E3

    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (-ve as X is normal)

    IC1
    IC2
    X3

    X2

    IE

    I/Px
    SE

    PE

    X1

    I/Px

    The assumption of X is normal means that for consumer good


    X and good Y has same priority, which also means that the
    indifference curve will shift parallel out or parallel inward.

    Hence we can see that when product is normal then


    substitution and income effect is in same direction

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to law of demand , decrease in price of X


    increases its demand from X1 to X3 which is also price effect.

    Case 3: Inferior good,


    decrease price

    Decrease in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to
    X3 (-ve as X is inferior)

    E3

    E1

    IC2

    E2

    IC1
    X1

    X3 X2
    PE IE
    SE

    I/Px

    I/Px

    Case 4: Inferior good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E3

    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is inferior)

    IC1
    IC2
    X2 X
    3

    X1

    IE PE
    SE

    I/Px

    I/Px

    The assumption of X is inferior means that for consumer good


    Y is preferred over good X, which also means that the
    indifference curve will shift away outward and shift near
    inward.

    Hence we can see that when product is inferior then


    substitution and income effect is in opposite direction

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to law of demand , decrease in price of X


    increases its demand from X1 to X3 which is also price effect.

    Case 5: Giffen good,


    decrease price

    Decrease in Px

    I/Py

    E3

    IC2

    E1
    E2

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to X3
    (-ve and more than subs
    effect in magnitude as X is
    giffen)

    IC1
    X3 X1
    PE

    X2
    SE
    IE

    I/Px

    I/Px

    Case 4: Inferior good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is inferior)

    IC1

    E3
    X2

    SE

    X1 X3
    PE I/Px

    IE

    IC2

    I/Px

    The assumption of X is giffen means that for consumer good


    Y is very preferred over good X, which also means that the
    indifference curve will shift far away outward and shift very
    near inward.

    Hence we can see that when product is giffen then


    substitution and income effect is in opposite direction. But
    the income effect is higher than substitution effect in
    magnitude.

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to exception in law of demand , decrease in


    price of X decreases its demand from X1 to X3 which is also
    price effect.
    This approach is used to make Compensated Demand
    curve.

    Slutsky Analysis
    According to Slutsky effect, for change in price consumer first
    substitutes is consumption bundle (good x, good y) within same
    purchasing power and after that income effect comes in where
    consumer shifts on higher indifference curve.

    Hence total Price effect is sum of Substitution effect and income


    effect
    PE = SE + IE
    Hence this analysis describes how price effect is partitioned.

    The benefit of this model is to see assuming budget constant, how


    does demand of good Y is changed if price of good X is changed
    and how much extra utility is gained for the price decrease and
    vice versa.

    The mechanism is when price decreases then budget line


    rotates hence price ratio changes, so consumer first do
    substitution by parallel shifting of new budget line downward
    on old equilibrium indifference curve. After this he jumps on
    new curve and line called as income effect.
    Substitution effect: Change in demand due to change in the
    rate of exchange (price ratio) between two goods keeping
    budget constant
    Income effect: Change in demand due to having more
    purchasing power
    Here we will perform 6 different cases
    1.
    2.
    3.
    4.
    5.
    6.

    Decrease in price of X when it is normal good


    Increase in price of X when it is normal good
    Decrease in price of X when it is inferior good
    Increase in price of X when it is inferior good
    Decrease in price of X when it is giffen good
    Increase in price of X when it is giffen good

    Case 1: Normal good,


    decrease price

    Decrease in Px

    I/Py

    E1

    E3

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is normal)

    E2
    IC2
    IC1
    X1

    X2

    SE

    I/Px
    IE

    PE

    X3

    IC1

    I/Px

    Case 2: Normal good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E3

    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (-ve as X is normal)
    IC1
    IC1
    IC2

    X3

    X2 I/P X1

    IE

    SE
    PE

    I/Px

    The assumption of X is normal means that for consumer good


    X and good Y has same priority, which also means that the
    indifference curve will shift parallel out or parallel inward.

    Hence we can see that when product is normal then


    substitution and income effect is in same direction

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to law of demand , decrease in price of X


    increases its demand from X1 to X3 which is also price effect.

    Case 3: Inferior good,


    decrease price

    Decrease in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to
    X3 (-ve as X is inferior)

    E3

    E1

    IC2

    E2

    IC1
    X1

    X3
    PE IE
    SE

    X2

    I/Px

    IC1

    I/Px

    Case 4: Inferior good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E3

    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is inferior)

    IC1
    IC1
    IC2
    X2 X
    3

    IE PE
    SE

    X1

    I/Px

    I/Px

    The assumption of X is inferior means that for consumer good


    Y is preferred over good X, which also means that the
    indifference curve will shift away outward and shift near
    inward.

    Hence we can see that when product is inferior then


    substitution and income effect is in opposite direction

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to law of demand , decrease in price of X


    increases its demand from X1 to X3 which is also price effect.

    Case 5: Giffen good,


    decrease price

    Decrease in Px

    I/Py

    E3

    IC2

    E1
    E2

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    cheap
    Price effect
    from X1 to X3
    Substitution effect from X1
    to X2 (+ve as X is normal)
    Income effect from X2 to X3
    (-ve and more than subs
    effect in magnitude as X is
    giffen)

    IC1
    IC1
    X3 X1
    PE

    X2
    SE
    IE

    I/Px

    I/Px

    Case 4: Inferior good,


    increase price

    Increase in Px

    I/Py

    Substitution from E1 to
    E2
    Here Y will fall as X is
    relative
    expensive
    Price
    effect
    from X to X
    1

    E2
    E1

    Substitution effect from X1


    to X2 (-ve as X is normal)
    Income effect from X2 to
    X3 (+ve as X is inferior)
    IC1

    IC1

    E3
    X2

    X1 X3
    PE I/Px

    SE
    IE

    IC2

    I/Px

    The assumption of X is giffen means that for consumer good


    Y is very preferred over good X, which also means that the
    indifference curve will shift far away outward and shift very
    near inward.

    Hence we can see that when product is giffen then


    substitution and income effect is in opposite direction. But
    the income effect is higher than substitution effect in
    magnitude.

    As indifference curve assumes that both products are weak


    substitutes hence in substitution effect the demand of other
    good is also changed.

    So according to exception in law of demand , decrease in


    price of X decreases its demand from X1 to X3 which is also
    price effect.

    This approach is called Equivalent Income Variation

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