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

CHAP. 5] ADVANCED TOPICS IN CONSUMER DEMAND THEORY 113
Panel A of Fig. 5-10 is identical to Fig. 5-1, except for the omission of all indifference curves and the Hicksian
budget line K 0 J 0 . The consumer is originally observed to be in equilibrium at point E on KL. When the price of X
falls from P x ¼ $1.00 to P x ¼ $0.50, the budget line becomes KJ and the consumer’s real income rises. To keep real
income constant as at point E, KL is rotated through point E in a counterclockwise direction until it is parallel to KJ.
The consumer will not consume along K 00 E because it is below KE, and KE is inferior to E. The consumer will
instead consume along EJ 00 , say, at point H. The movement from E to H (3X) is the substitution effect shown in
the bottom panel by the Slutsky demand curve. If the consumer’s real income is now allowed to rise with
budget line KJ, the consumer will purchase more of commodity X if X is a normal good. If the consumer moves
to point T, the movement from H to T (1X) is the income effect. The usual demand curve shown in panel B illustrates
the total of the substitution and income effects resulting from the fall in P x . Thus, the theory of revealed preference
can be used to separate the (Slutsky) substitution from the income effect and derive the Slutsky and the usual
demand curves without any need for indifference curves.
Fig. 5-10
PRICE INDEX NUMBERS AND CHANGES IN THE STANDARD OF LIVING
5.6 Given the hypothetical price and consumption data of Table 5.2 and using 1984 as the base year, find E,
L, and P and indicate the change in the standard of living for (a) 1989, (b) 1990, and (c) 1991.
Table 5.2
Year P x X P y Y
1984 (base) $4 5 $3 3
1989 5 6 4 6
1990 6 4 5 4
1991 6 4 7 4