Slutsky theorem

consumer preference theory

1. Slutsky’s theorem Presented by Suparna Pani Date – 10/5/2015 Jain University - MA Economics 2015

2. INTRODUCTION When price of something goes down, we buy more of it. This lead to two effect: INCOME EFFECT : it becomes less expensive , we have more purchasing power SUBSTITUTION EFFECT: it offers more utility per unit of money Price effect is the sum of substitution effect and income effect for a price change which is known as slutsky’s theorem Jain University - MA Economics 2015 2

3. Marshallian demand or Uncompensated demand curve Hicksian demand or Compensated demand curve S lutsky theorem 1.It deals with how demand changes when price changes holding money income constant 2.It maximise utlity given price and wealth 3.Marshallian demand is easier to observe 1.It deals with how demand changes when price changes holding the real income constant or utility constant 2.It minimise expenditure 3.Hicksian demand is more mathematically tractable 1.It is the total (Marshallian) price effect is equal to the sum of the substitution effect ( i.e,Hickisan price effect) plus income effect. Both function are related by slutsky eqation . Jain University - MA Economics 2015 3

4. Mathematically Its based on derivation of marshallian and hicksian demand ∂xi⁄ ∂ p j = ∂hi/ ∂pi – ( x j * (∂xi/ ∂m)) TE SE IE Total effect: it shows total quantity of x that we consume varies when we change price Substitution effect: Variation is due to finding similar product(obtain from derivation of the Hicksian demand with regard price) Income effect: change in our purchasing power affect the amount we consume of a certain goods(derivation of Marshallian demand with regard wealth) Jain University - MA Economics 2015 4

5. GRAPHICALLY Jain University - MA Economics 2015 5

6. ANALYSIS OF AGGREGATE EFFECT – DIFFERENT GOODS Price Substitution Effect Income Effect Total Effect = Substitution Effect + Income Effect Normal good ↓ X _ ↓ X _ ↓X+ ↓ X= ↓X( _) Inferior good 1.[SE]>[IE] 2.[SE]<[IE] { Giffen goods} 3.[SE]=[IE] ↓ X _ ↓↓ X _ ↓ X _ ↓ X _ ↑ X + ↑ X + ↑↑ X + ↑ X + ↓ X+ ↑ X= X ? ↓ ↓X+ ↑ X=↓ X(_) ↓ X+↑↑ X=↑X(+) ↓ X+ ↑ X=X Independent good ↓ X _ X:constant (no income effect) ↓ X+ 0= ↓ X( _) Jain University - MA Economics 2015 6

7. THANK YOU Jain University - MA Economics 2015