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Slutsky Equations
De…nition: Let
X
m= pi xi (1)
where x is called an endowment. The Slutsky Demand Function is de…ned as:
1
2
3
4
Hicksian Demand Functions
5
Examples
1. Cobb Douglas
u(x1 ; x2 ) = xa1 1 xa2 2
a 1 a
p1 a1 h1 1 h2 2
M infp1 h1 + p2 h2 : ha1 1 ha2 2 = u0 g gives p2 = a2 ha1 h1 a2
1 2
p1 a1 h2 a1 a2 p2 a1 a1 a2
or p2 = a2 h1 :Combine this with h1 h2 = u0 to get p1 a2 h2 h2 = u0
or
a1
ha2 1 +a2 = u0 pp21 aa21 : This leads to
a1
0 0a 1 p1 a2 a1 +a2
h2 (p1 ; p2 ; u ) = u 1 +a2 (8)
p2 a1
and a2
0 0a 1 p2 a1 a1 +a2
h1 (p1 ; p2 ; u ) = u 1 +a2 (9)
p1 a2
and so that @h @h2
@p1 and @p2 are negative. These are the Hicksian substi-
1
tution e¤ects.
2. Quasi-linear.
u(x1 ; x2 ) = a1 ln (x1 )+x2 : minf(p1 h1 +p2 h2 ) : a1 ln (h1 )+
h2 = u0 g gives pp21 = ha11 so that
a1 p2
h1 (p1 ; p2 ; u0 ) = (10)
p1
and
a1 p2
h2 (p1 ; p2 ; m) = u0 a1 ln (11)
p1
with dh dh2
dp1 < 0 and dp2 < 0:Notice that the Hicksian and Marshallian demand
1
3. Square Root
1
1 1 1 1 1 2
p1 2 h1
u(x1 ; x2 ) = x12 + x22 : minf(p1 h1 + p2 h2 ) : h12 + h22 = u0 g gives p2 = 1 =
1 2
2 h2
1
1 1 1 1 1
h22 p1 2 p1 2 p1 +p2
1 so that h22 = p2 h1 or h12 + p2 h2 = u0 ) h12 + p2 = u0 so that
h12
2
p2 u0
h1 (p1 ; p2 ; u0 ) = 2 (12)
(p1+ p2 )
and
2
0 p1 u0
h2 (p1 ; p2 ; u ) = 2 (13)
(p1+ p2 )
dh1 dh2
with dp1 < 0 and dp2 < 0:
6
Slutsky Equation (Hicksian)
Law of Demand
@xi
@pi < 0 if good i is normal or when @x
@m > 0:
i