Question

Using the Slutsky Equation, determine if the following are True, False, or Uncertain:

(a) If a good is a normal good, the demand function must have a negative slope

(b) If a good is an inferior good, the demand function must have a positive slope

Answer 1

Slutsky equation demonstrate that the change in the demand for a good, caused by a price change, is the result of two effects : subsitution effect and income effect.

a) True.

Explanation:

: Normal goods are those in which demand increase with income.

: The substitute and income effects reinforces each other when a normal goods own price changes.

: When both the subsitute and income effects increases demand when own-price falls, a normal good's ordinary demand curve slopes down.

: The law of downward sloping demand, always applies to normal goods.

b) True.

Explanation:

: Inferior goods are those in which demand is reduced by higher income.

: The subsituation and income effect oppose each other when an income inferior good's own price changes.

: The overall change in demand of inferior goods are the sum of the substitution and income effect.

: The pure substitution effect is as for norml good, but the income effect is in opposite direction.