Intermediate Microeconomics Chapter 8: Income/Substitution Effect

substitution effect

portion of price change effect that creates a substitution of one good for another (often the cheaper good is subbed for the more expensive good, and new optimal bundle contains more of the cheaper good)

income effect

portion of price change effect that effectively acts as an income change for the consumer and shifts budget constraint and optimal bundle inward or outward

for normal goods, income effect and substitution effect have ________ sign.

the same

substitution effect has the _______ sign of price change

opposite

total effect = substitution effect + income effect

Slutsky equation

for inferior goods, substitution and income effect go in ___________ directions.

different

Giffen goods

inferior goods for which the income effect is positive enough to cancel out the substitution effect’s negative sign and result in a positive total effect

Disadvantage of Slutsky decomposition effects

consumers can be overcompensated when final bundle is on a higher indifference curve from the original bundle

Hicks decomposition

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