Question

In detail discuss what the slutsky equation is and it's importance in consumer theory

Answer 1

The Slutsky equation says that the total change in demand is composed of an income and a substitution effect and that the two effects together must equal the total change in demand:

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This equation is helpful to describe how distinct kinds of goods are indicated by modifications in demand. The curves of indifference are always sloping downwards, so the impact of replacement must always be negative. But the impact on revenue may not be, depending on how good revenue changes consumption.

A normal good has a adverse impact on revenue, and so if the price decreases and thus the purchasing power or revenue increases, demand increases. The opposite holds when the price is rising and the purchasing power or revenue is falling, as demand then is falling.

But not all products are "normal." In an financial sense, some are inferior. That doesn't imply they are of bad quality, but they have a adverse earnings profile — a individual consumes less of them as revenue increases. For example, instant noodles are usually not considered a product that individuals eat unless they are restricted in terms of cash; you eat less of them as you get richer. In this situation, the impact of replacement is negative, but the impact of revenue is negative as well.