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The first term on the right-hand side represents the substitution effect, and the second term represents the income effect. [1] Note that since utility is not observable, the substitution effect is not directly observable. Still, it can be calculated by referencing the other two observable terms in the Slutsky equation.
The Hicksian demand function isolates the substitution effect by supposing the consumer is compensated with exactly enough extra income after the price rise to purchase some bundle on the same indifference curve. [2] If the Hicksian demand function is steeper than the Marshallian demand, the good is a normal good; otherwise, the good is inferior.
The substitution effect is the change that would occur if the consumer were required to remain on the original indifference curve; this is the move from A to B. The income effect is the simultaneous move from B to C that occurs because the lower price of one good in fact allows movement to a higher indifference curve.
The book decomposes the change into the substitution effect and the income effect. The latter is the change in real income in theoretical terms without which the distinction between real and nominal values would be more problematic. The two effects are now standard in consumer theory. The analysis conforms with a proportionate change in money ...
The substitution effect says that if the demand for both goods is homogeneous, when the price of one good decreases (holding the price of the other good constant) the consumer will consume more of this good and less of the other as it becomes relatively cheeper. The same goes if the price of one good increases, consumers will buy less of that ...
The book built on ordinal utility and mainstreamed the now-standard distinction between the substitution effect and the income effect for an individual in demand theory for the 2-good case. It generalised the analysis to the case of one good and a composite good, that is, all other goods. It aggregated individuals and businesses through demand ...
When other factors of production can be easily substituted for the category of labor (substitution effect). When the supply of other factors of production is highly elastic (that is, usage of other factors of production can be increased without substantially increasing their prices) (substitution effect). That is, employers can easily replace ...
Slutsky is principally known for work in deriving the relationships embodied in the Slutsky equation widely used in microeconomic consumer theory for separating the substitution effect and the income effect of a price change on the total quantity of a good demanded following a price change in that good, or in a related good that may have a cross-price effect on the original good quantity.