Income and Substitution EffectsA. Explanation of the Topic of InterestB. Definition of the Income and Substitution EffectsUsing and Indifference Map to Identify Income and Substitution Effects***C. Applying What We Know About Income and Substitution Effects in Order to Determine the Conditions under which a Demand Curve is Downward SlopingA. Explanation of the TopicSuppose that the budget line changes. For example, suppose that the price of good X increases. units of good Y per week Budget Line before the Price of Good X Increases units of good X per weekAs a result of the new budget line, the individual selects a different consumption bundle. How much of the change is attributable to (i)(ii)C. Using the Income and Substitution Effects to Determine the Conditions Under which the Demand Curve is Necessarily Downward SlopingAssume an individual with an indifference map satisfying the usual assumptions (ICs are downward sloping, non-intersecting, and bowed in towards the origin and bundles on ICs curves farther from the origin are liked better than those on ICs closer to the origin).1. Increase in the price of good XReminder: To find the SE, we construct a hypothetical BL for the new prices and tangent to the IC with the optimum for the old prices. The SE for good X is the change in X from (i) the initial optimum for the original prices to (ii) the tangency of the hypothetical BL to the IC for the initial optimum.Reminder: In finding the IE, we first identify the SE. The IE for good X is the change in X (i) from the tangency of the hypothetical BL to the IC with the initial optimum to (ii) the optimum for the new BL.2. Decrease in the price of good XSubstitution EffectIncome Effect3. SummaryEffect of an Increase in the Price of Good X on the Optimal Consumption of Good XNormal Good Inferior GoodSubstitution EffectIncome EffectTotal EffectEffect of a Decrease in the Price of Good X on the Optimal Consumption of Good XNormal Good Inferior GoodSubstitution EffectIncome EffectTotal
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