Question

Suppose the price of one good increases. What is the substitution and the income effect of this price change? What else do you need to know to fully answer this?

Answer 1

Substitution and Hicksian Income effects After the decrease in the price of Commodity x but budget line solates from 4-X to Y-R 4. Hicks bifurcated the too effects X X X X 64 deutes vreducing the real income Substitution etter (-). X, Y = to original one that was before X2 - Xz = Income offer ( price change. X, * = Total effect (-) New budget line 4,-Xs is dracon which is paraules to budget line altes increase in income and tangent to the original Indifference Curve Hicks keeps the Consumer on the same level of salisfaction while Slutslly keeps the real income Constant while keeping the Consumer with original bean of baskets of goods. & of Substitution effect is the increase in quantity bought of as the price so as keep the new Commodity purchasing falls, after power of adjusting income the Consumer the as before. This allestment in income is called compensating Variation. Movement from et to E, shows the substitution effect. It is because good se becomes relatively cheaper to that Why Consumer Substitute the y with X.

Income from I movement to Er is called income effect. effect arises when to changes in Income of consumer affects the goods consumed. After Substitution effect in which more of t is purchased and less of Y but income increases would be spent on both the goods thats why both the commodities are purchased in income effect Adding both the effects will give total effect of a price change which is negative. Substitution effect of a price change is always negative In case of normal goods, Inferior and giften goods Income effect or a price change will be negative for normal goods. Conly income effect would be positive but Income effect of a price will be negative, change