1. AKSHAY MAHAJAN (18)
AMIT AGGARWAL(19)
VAIBHAV SHARMA(87)
SURESH KUMAR(83)
BHRIGU MONGA(32)

2.  Changes to quantities demanded due to this
„extra‟ income are the income effect of the
price change.
 Price and income substitution effects can
cause change in taste and preferences.
 They also change the quantity intake.

3.  LIKE– a person salary increased so the
commodity he was buying earlier can change
or may be increased.
 The price of tea increased then the customer
will shift to coffee.
 The Income Effect is the effect due to the
change in real income. For example, when the
price goes up the consumer is not able to buy
as many bundles that he could purchase
before. This means that in real terms he has
become worse off

4.  Economists often separate the impact of a
price change into two components:
◦ the substitution effect; and
◦ the income effect.

5.  The decomposition of the price effect into the
income and substitution effect can be done in
several ways
 There are two main methods:
(i) The Hicksian method; and
(ii) The Slutsky method

6.  Sir John R.Hicks (1904-1989)
 Awarded the Nobel Laureate in Economics
(with Kenneth J. Arrrow) in 1972 for work
on general equilibrium theory and welfare
economics.
 Hicksian (compensated) demand curves
cannot be upward-sloping (i.e.
substitution effect cannot be positive)

7.  Itis totally depends on the real income of
the consumer.
 This method states that if the income of the
consumer increases then the level of
consumption power of remain same.
 The utility remains constant.

8. The remainder of the total effect is due
X2 to a change in real income. The
increase in real income is evidenced by
the movement from I1 to I2
Eb
Ea I2
Ec
I1
X1
Income Effect

9.  Eugene Slutsky (1880-1948)
 Russian economist expelled from the
University of Kiev for participating in
student revolts.
 In his 1915 paper, “On the theory of the
Budget of the Consumer” he introduced
“Slutsky Decomposition”.

10.  To isolate the substitution effect we adjust
the consumer‟s money income so that s/he
change can just afford the original
consumption bundle.
 In other words we are holding purchasing
power constant.

11.  To isolate the substitution effect we adjust
the consumer‟s money income so that s/he
change can just afford the original
consumption.
 In other words we are holding purchasing
power constant.

12.  Slutsky claimed that if, at the new prices,
-less income is needed to buy the original
bundle then “real income” has increased
- more income is needed to buy the
original bundle then “real income” has
decreased

13. The new optimum on I3 is at
Ec. The movement from Ea to
X2 Ec is the substitution effect
Eb
Ea I2
Ec
I3
xa xc
X1
Substitution Effect

14.  The main difference is that Hicks keeps
utility constant rather than keeping
purchasing power constant. The Slutsky
substitution effect gives the consumer just
enough money to get back to his old level of
consumption while the Hicks gives the
consumer just enough money to get back to
his old indifference curve