Year 12s: what will be the first way you research your future options? >>

Question on total effect

Hi,

I am unsure about the difference between the Hicksian method and the Slutsky method for income effect and substitution effects.
I read in the textbook that real income is held constant in the substitution effect for Slutsky'method; whereas utility is held constant for Hicks method. I have looked at both diagrams but I am not able to spot any differences. What actually does the above mentioned mean? And what actually are the difference? Also what about Marshallian's approach, does that supports Hicks method or is that a different approach?

Thank you

Reply 1

jpt4749

Not quite sure if my answer will be what you’re after but I will show an example in case it might help Suppose there are 2 goods, X&Y on X and Y axis respectively.

Suppose the price of X rises with Y stays constant.

The substitution effect will always be negative as the substitute is relatively cheaper so the quantity for X will decrease.

The income effect has impact on real income and it depends on the type of good which can be divided into 3 main categories

Normal good : Quantity of X will also decrease which double the negative effect

Inferior good : Quantity of X will increase but the effect will be less than the substitution effect so overall the effect will still be negative (decreasing)

Giffen Good : this is the weirdest type as the Quantity of X will increase and will outweigh the substitution effect so overall effect will turn out to be positive (increasing)

I have also attached a graphical illustration which might give a clearer picture :smile: