Question

Briefly describe three different ways of obtaining Hicksian demand functions.

Answer 1

The Hicksian welfare measures can be used for the evaluation of any change of state as long as the agent’s indirect utility for income is well defined before and after the change

The ways of obtaining this function are:

Compensating variation in income

In the method of breaking up price effect by compensating variation we adjust the income of the consumer so as to offset the change in satisfaction resulting from the change in price o a good and bring the consumer back to his original indifference curve, that is, his initial level of satisfaction which he was obtaining before the change in price occurred. For instance, when the price of a commodity falls and consumer moves to a new equilibrium position at a higher indifference curve his satisfaction increases.

Breaking up Price Effect: Equivalent Variation in Income

Price effect can be split up into substitution and income effects” through an alternative method of equivalent variation in income. The reduction in price of a commodity increases consumer’s satisfaction as it enables him to reach a higher indifference curve. Now, the same increase in satisfaction can be achieved through bringing about an increase in his income, prices remaining constant.

No excess utility and a uniqueness

Suppose if the price change, the function gives the level of demand that would arise if the consumers wealth were simultaneously adjusted to keep his/her utility level at u. Government helps consumer through subsidized goods. In India, it is done through public distribution system. This type of wealth compensation to consumer is depicted in above diagram. It is known as Hicksian wealth compensation.