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

110 ADVANCED TOPICS IN CONSUMER DEMAND THEORY [CHAP. 5
Solved Problems
THE SUBSTITUTION EFFECT ACCORDING TO HICKS AND SLUTSKY
5.1 Redraw Fig. 4-29 to show on that figure the Slutsky substitution and income effects and the Slutsky
demand curve.
Fig. 5-6
In panel A of Fig. 5-6, the Slutsky budget line is 4 00 and the substitution effect is 3X given by the movement
from point E to point L. This gives the Slutsky demand curve d 00 x in panel B (sometimes referred to as the “compensated
demand curve”), while dx 0 is the Hicksian demand curve and d x is the usual demand curve (as in panel
B of Fig. 4-29).
5.2 With regard to the Slutsky and Hicksian substitution effects (a) which is a better measure? (b) As the
magnitude of the price change declines, what happens to the magnitude of these two measures of the
substitution effect?
(a)
(b)
The Slutsky measure of the substitution effect is generally better because it puts the consumer on a different
indifference curve, as does the income effect. More importantly, the Slutsky substitution effect can be
measured from actual price-quantity observations before and after the price change, and without any
knowledge of the exact shape of the indifference curve.
As the magnitude of the change in P x declines, the difference between the Slutsky and Hicksian substitution
effects declines and approaches zero faster than the decline in the Slutsky and Hicksian substitution and
income effects (see panel A of Fig. 5-6).