Slutsky Equation
3 important questions on Slutsky Equation
What two effects occur when the price of a good one changes?
- Substitution effect: the rate at which you purchase good two instead of good one changes.
- Income effect: your purchasing power will increase/decrease and you will buy more of good one.
Describe the pivot-shift operation.
- Pivot the slope budget line around the original chosen bundle, towards the new adjusted prices.
- Shift the budget line towards the preferred purchasing power.
How do you recognize a Giffen good in the Slutsky identity?
When the income effect would have to outweigh the substitution effect with a different sign (+/-)
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