Question

2. Based on the Slutsky Equation and relevant theorems, discuss in your own words about the reactions of quantity demanded to price and income changes (Law of Demand - Theorem 1.13).

Answer 1

According to Slutsky and other relevant theorems by Hicks shows an extention in the law of demand. Law of demand says that other things remain same, an increase in price of a commodity decrease its demand. Slutsky explains that there are two reasons for decrease in demand of a commodity when its price rise. They are the substitution effect and income effect.

The substitution effects is an increase in the price of a commodity makes it relatively more expensive. So the consumer demand more of other goods which is relatively cheaper. That means the decrease in the demand of commodity those price is rise.  For example, if the price of good x is increase good x will relatively expensive than good y. So the consumers demand more of good y. Automatically the demand for good x decrease.

The income effect is the rise in the price of commodity the purchasing power of the consumer decrease that means there is indirectly a decrease in the income of the consumer. So they demand less quantity of the commodity.