Datasets:
olimiemma
/
MIT-OCW-Transcripts

Dataset card Data Studio Files
xet
 Community
1
text
stringlengths
0
205
PROFESSOR: All right.
So today we are going to start
by reviewing income and
substitution effects.
Because that's a pretty hard
concept and pretty central to
a lot of what we'll do for
the rest of the semester.
And then we're going to dive
in and talk about an
application, a more interesting
application, of
income and substitution effects
which is the effects
of wages on labor supply.
So let's review.
If you take the handout, grab
the handout and look at the
first figure, it's the same
as the last figure of the
previous lecture.
To review, remember, whenever
the price changes, a price
change can be decomposed into
two effects, the substitution
effect and the income effect.
The substitution effect is the
change in the quantity
demanded when the
price changes,
holding utility constant.
And as we proved last
time, that is always
negative, 0 or negative.
It is always non-positive.
It's always true that when
a price goes up, the
substitution effect
is negative.
We proved that both
mathematically and graphically
last time showing that if you're
going to hold utility
constant, and the price of a
good is going to go up, you're
going to shift away
from that good.
OK.
That's the substitution
effect.
In our example, we showed
graphically how you measure a
substitution effect.
You draw a new imaginary budget
constraint, BC3, which
is parallel to the new budget
constraint, BC2.
So it's got the new price ratio
but tangent to the old
indifference curve.
So the key thing to understand
is the imaginary budget
constraint, BC3, where