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AP ECON 2300 F2012 Session 5.doc

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ECON 2300
Wai Ming Ho

AP ECON 2300 F2012 Session 5 Instructor Dr David K Lee Page 1 of 14Department of EconomicsYork University Topic Slutsky Equation and Intertemporal ChoicesReading Chapter 8 and 10Effects of a Price ChangeWhat happens when a commoditys price decreasesSubstitution effect the commodity is relatively cheaper so consumers substitute it for now relatively more expensive other commoditiesIncome effect the consumers budget of y can purchase more than before as if the consumers income rose with consequent income effects on quantities demandedEffects of a Price ChangeConsumers budget is yx2Lower price for commodity 1pivots the constraint outwardsNow only y are needed to buy theoriginal bundle at the new prices as if the consumers income hasincreased by y yx1 2010 W W NortonCompany Inc6Changes to quantities demanded due to this extra income are the income effect of the price changeSlutsky discovered that changes to demand from a price change are always the sum of a pure substitution effect and an income effectReal Income ChangesSlutsky asserted that if at the new pricesless income is needed to buy the original bundle then real income is increasedmore income is needed to buy the original bundle then real income is decreasedReal Income Changesx2Original budget constraint and choiceNew budget constraint realincome has risenx1 2010 W W NortonCompany Inc12Pure Substitution EffectPage 2 of 14
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