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SLUTSKY EQUATION

(In economics) the relationship among the price elasticity of demand, the substitution leasticity of demand, and the income elasticity of demand.
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soojin park

on 27 May 2010

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Transcript of SLUTSKY EQUATION

Slutky equation what is it? the relationship among
the price elasticity of demand,
the substitution elasticity of demand, and the income elasticity of demand.
still don't know? That is, in market we can see
the total effect from a price
change decomposed into a substitution effect and an income effect. Total effect = substitution effect + Income effect + = where we can use it? ex)
apply it to determine how likely a good is to e a Giffen good based on whether it has a large or a small budget share.
to determine the effect of government policies that compensate some consumers Let's see the equation!! captures the total effect of a
price change - the change along an
uncompensated demand curve. It can break
this price elasticity of demand into two
terms involving elasticities that capture
the substitution and income effects It can be measured using the
pure substitution elasticity of
demand, which is the percentage that the quantity demanded falls for a given percentage increase in price if we compensate the consumer to keep the consumer's utility constant.
That is, it is the elasticity of the
compensated demand curve. The income effect is the income
elasticity, times the share of the
budget spent on that good. examples.
summary
Mimi buying beer for a year
Price = $12
Q boutgh = 26.7 gallons
Her beverge budget = $419
Price change to $6
Q2 = 44.5 gallons Let's make up number! Let's interprete the result! share of the budget=0,76=(12*26.7)/419=0.88
income elasticity=-0.76
prie elasyiciy=-0.09
Calculate the result! -0.76 = -0.09 + 0.76*0.88 (As beer is a normal good for mimi)
the size of total change is deu more
to the income effect than to the substitution
effect. If the price of beer rises by 1%
but Mimi is given just enough extra income
so that her utility remains constant, Mimi would
reduceher consumption of beer bt less than a tenth
of a percent(substitution effect).Without compensation, Mimi reduces her consumptionof beer by about three-quarters of a percent(total effect) This equaion is derived mathematically from graphical
relationship that the total effect from a price change
be decomposed into a substitution effect and an income
effect. Using the numbers calculated, we can observe
those realationship precisely.
Thank you :)
Full transcript