Question

consider a consumer who consumes two goods x and y , priced at px and py respectively . suppose price of good x raises to px , decompose price effect of this price increase into substitutional and income effect using Hiksian apporach

Answer 1

Explanation:

Price effect of this price increase into substitution and income effect using Hicksian approach.

Explanation:

Hicksian Approach

A change in the price of a commodity alters the quantity demanded by consumer. This is known as price effect. Hence, this price effect comprises of two effects i.e. substitution effect and income effect.

For example, a consumer consumes two goods X  and Y, priced at Px and Py. If the price of good X rises to Px. Then it proves by Hicksian Approach.

 

A price of one commodity falls, the consumer substitutes the cheaper commodity for the costlier commodity. This process is known as substitution effect.

According to Hicksian method of eliminating income effect, we just reduce consumer’s money income. The consumer equilibrium changes from good Y to good X. This means that an increase in quantity demanded of commodity X is purely because of substitution effect.  

We get income effect by subtracting substitution effect from the total price effect.

Income Effect = total price effect – substitution effect