Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

92 CONSUMER DEMAND THEORY [CHAP. 4
Fig. 4-28
(b) The movement from point E (on indifference curve II) to point G (also on indifference curve II)
represents the substitution effect of the price change. The movement from point G (on indifference
curve II) to point T (on indifference curve III) is the income effect of the price change. Thus, for
the given price change
Total Effect ¼ Substitution Effect þ Income Effect
ET ¼ EG þ GT
(c) In panel B of Fig. 4-28, dx 0 shows only the substitution effect of the price change. Thus, d x 0 is the consumer
demand curve for commodity X when the consumer’s real rather than money income is kept
constant. Some economists prefer this type of demand curve (i.e., dx 0 ) to the usual demand curve
(that keeps money income constant). Unless otherwise specified, by “demand curve” we will always
refer to the traditional or usual demand curve.
The technique for separating the income effect from the substitution effect shown in panel A of
Fig. 4-28 is useful not only for deriving a demand curve along which real income is constant but
also (and perhaps more importantly) because it is a very useful technique for analyzing many problems
of great economic importance. Some of these are presented in the section on applications that follows.
4.33 Starting from Fig. 4-26, (a) separate the substitution effect resulting from the reduction in the price
of X from $2 to $1 per unit (ceteris paribus), (b) derive the consumer’s demand curve for commodity
X when real income is kept constant, (c) with reference to the figure in parts (a) and (b),
explain how you derived the demand curve for commodity X along which money income is kept