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

70 CONSUMER DEMAND THEORY [CHAP. 4
EXAMPLE 15. Line E 0 T 0 in Fig. 4-9 is the demand curve for commodity X for the consumer in Example 14. It
shows that when P x ¼ $1, the consumer purchases 5X, while when P x falls to $0.50, ceteris paribus, he or she
purchases 9X.
Fig. 4-9
When the slope of the price-consumption curve is positive as in Fig. 4-8, then d x is inelastic. Thus, at P x ¼ $1, this
consumer buys 5X and spends $5 on it. When P x falls to $0.50, the consumer buys 9X and spends $4.50 on it.
Since the amount spent on X falls when P x falls, we know from Section 3.3 that d x (in Fig. 4-9) is price-inelastic
over arc E 0 T 0 e ¼ DQ
DP P E 0 þ P T 0
¼
Q E 0 þ Q T 0
4
0:50 1:50 ffi 0:86
14
When the slope of the price-consumption curve is zero, d x is unitary price-elastic; when the slope of the price-consumption
curve is negative, d x is price-elastic (see Problem 4.30).
4.11 SEPARATION OF THE SUBSTITUTION AND INCOME EFFECTS
We saw in Fig. 4-8 that when P x falls from $1 to $0.50 (cet. par.), we move from point E to point T and Q x
rises from 5 to 9 units. Since X is a normal good, the income effect here reinforces the substitution effect in
causing the rise in Q x .
We can separate the income effect from the substitution effect of the price fall by reducing the consumer’s
money income sufficiently to keep real income constant. This can be accomplished by shifting budget line KJ in
Fig. 4-8 down and parallel to itself until it is tangent to indifference curve II. The movement along indifference
curve II will give us the substitution effect. The total effect of the price change (ET) minus the substitution
effect will give us the income effect (see Problem 4.32). Having done this, we could then derive a demand
curve showing only the substitution effect (i.e., a demand curve along which real income rather than money
income is kept constant—see Problem 4.32).
Problems 4.37 to 4.42 deal with some important considerations and applications of indifference curve
analysis. Problem 4.37 deals with the relationship between the utility and the indifference curve approach to
consumer demand theory, 4.38 with substitute and complementary commodities, 4.39 with the evaluation of
alternative government assistance programs, 4.40 with the choice between income and leisure and overtime
pay, 4.41 with time preference, and 4.42 with time as an economic good.