With the aid of diagrams describe the Slutsky decomposition for both price rises and price falls for all types of goods.

With the aid of diagrams describe the Slutsky decomposition for both price rises and price falls for all types of goods

The Slutsky decomposition is all about analysis and breaking up into simple pieces to determine the behaviour of the whole (Carmen , Wang 2005

From the above diagram it is easy to see that all changes are hypothetical and each change should be seen in isolation and we need to examine the result when these changes are added

In substitution effect the purchasing power is fixed while demand changes along with

price . This isolation is due to the fact that relative prices are affected therefore substitution is negative because of visible preference . This means the quantity demand is in contrast to the direction of the price (Chaudhuri A .1995

The income effect shows that increase is income keeps the prices fixed while the effect on income which may be either increase or decrease depending on the product which might be inferior or normal

The X is the maximum utility point then if price falls for goods the consumer 's maximum utility will change to Z . The shift to Y from X is the substitution effect . This individual can be substituted for good a or good b because it is cheaper . Changes in goods price occurs when good a 's price changes which causes movement of the point Y to Z . If a is a normal good , more will be bought due to the increase in real income . If good 's are normal then there is a reinforcement of substitution and the income effect which highlights two points namely fall in goods prices affects demand in quantity and with increase in price there is a natural drop in demand for the quantity ( HYPERLINK "http /s .ssrn .com /sol3 /cf_dev /AbsByAuth .cfm ?per_id 578244 " \t "_blank " Patra .N , 2006 . Inferior goods on the other hand show substitutions and income effects in reverse directions . This combined effect gives rise to two points namely when price rises then the substitution effect causes a drop in quantity on demand while the income effect is opposite . The next point being that with increase in price substitution effect causes rise in quantity in demand while the income effect is opposite . This substitution and income effect show maximum utilization for normal goods or even utility maximization for normal goods when there is increase in price which corresponds to a decline in demand for the goods (Allen .R .G .D 1950

The Slutsky equation can therefore be written as following

Where (E (px x , representing 1 increase ifor all px rises is necessary for expenditures by x dollar and 1 in addition must be paid for every unit of x that is purchased

List of References

Carmen F . Menezes , X . Henry Wang (2005 . Duality , income and substitution effects for

the competitive firm under price uncertainty . Managerial and Decision

Economics . 26 , 4 . 249-257 . John Wiley Sons , Ltd

Allen .R .G .D (1950 . The Work of Eugen Slutsky Econometrica , Vol . 18...