Meaning of Utility

• The level of satisfaction or happiness that

consumer receives from the consumption of
goods and services is called utility.
• It is the human want satisfying power of goods
and services.
• It is a subjective entity and varies from person to
person, time to time and place to place.
 Approaches to utility analysis:

1. Cardinal approach:
• Developed by neo-classical economists
• this method assumes that the utility or level
of satisfaction that the consumers derive from
the consumption of goods and services can be
measured in numbers like height and weight.
• Utility can be assigned a cardinal number like,
1,2,3 etc.
• Also known as marginal utility analysis.
• The measuring unit of utility is ‘Utils’
 Cont………..
2. Ordinal utility analysis:
• The modern economists have discarded the
concept of cardinal utility and have instead
employed the concept of ordinal utility
analysis for analyzing consumer behavior.
• This method assumes that utility cannot be
measured in number but it can be ranked like
first, second, more or less.
 Cont…………
• The ordinal utility implies that the consumer is
capable of simply comparing the different
levels of satisfaction’.
• For example, a consumer may not be able to
tell that orange gives 10 utilities and apple
gives 20 utilities. But he always tell that apple
gives more utility than orange.
 Cont………….
• Utility being a psychological feeling is not
quantifiable.
•  According to the ordinal utility hypothesis, while
the consumer may not be able to indicate the
exact amounts of utilities that he derives from
commodities or any combination of them, but he
is capable of judging whether the satisfaction
obtained from a good or a combination of goods
is equal to, lower than, or higher than another.
 Concepts of total and marginal utility
Total utility:
• it refers to the total satisfaction derived by the
consumer from the consumption of a given
quantity of goods.
• In other words, it is the aggregate of marginal
utilities.
• Mathematically,
TU=∑MU
TU= MU1+MU2+…………..MUn
 Marginal utility
• The additional made to the total utility by
consuming one more unit of a commodity.
MUn= ∆ TU/ ∆ Q
MUn=TUn-TUn-1
∆=Change
TU= Total utility
MUn= marginal utility of nth units
Tun= total utility of nth units
 Types of Marginal Utility
1. Positive marginal utility: when total utility increases
with the consumption of additional units of the
commodity, then the marginal utility derives in a
positive form even if it is decreasing.
2. Zero utility: no addition to the total utility by
consumption of an additional unit (total utility
becomes maximum).
3. Negative utility: when the total utility decreases with
each successive unit of the commodity, the marginal
utility becomes negative.
Law of diminishing Marginal utility
a. introduction
This is an important law in economics. It is
equally applicable in all parts of economics.
This law was propounded by a famous
economist HH Gossen in 1854 AD. Therefore it
is also called as Gossen’s first law. Finally this
law was fully developed by Alfred Marshall.
 Cont………..
b. Statement: this law says that the additional
level of satisfaction goes on diminishing with
every increase in units of consumption within
same period of time. When consumer
consumes more and more units of the same
commodity, the successive level of satisfaction
diminishes.
 Cont…………..
b. ASSUMPTIONS
The Law of Diminishing Marginal Utility is based
upon the following assumptions:
 The consumer should be rational:
The consumer is regarded as the rational person
who aims to maximize their satisfaction with
their perfect knowledge required to maximize
the satisfaction of the constraints imposed by
their income and commodities
 Cont………

 Cardinal measurement of utility:

The consumption utility of any commodity can be measured. It
is assumed that the satisfaction can be measured in the same
way that the natural units of consumption can be calculated.
 Constant Marginal utility of money:
This theory assumes utility can be measured in terms of cordial
number. The basis of measurement of utility is money. Money
is the measuring rod of utility. Being a measuring rod of
utility, the marginal utility of money remains constant over
the period of consumption.
 Cont………..
 Homogeneous units of goods:
The units of goods consumed by the consumer
must be identical size. i.e homogeneous and
same quality. otherwise, the law will not apply.
 No change in task and preferences of the
consumer:
It is required that the preference of the consumer
do not change. Only then we can assume that the
marginal utility declines as consumption increase.
c. Explanation:
i. It can be explained with the help of the
following table.
Units of goods TU(Utils) MU
0 0
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 -2
 Cont………..
• The given table shows that a consumed goes on
consuming goods the additional utility or marginal utility
that the consumer obtained by consuming each
successive unit of goods of 'x' goes on decreasing till it
goes down to zero at the sixth unit and it becomes
negative with the 7th unit. The total utility goes on
increasing until the consumption of 5th unit and in the
6th unit the total utility stays constant but decreases in
the 7th unit. The total utility increases at a diminishing
rate. It is due to the diminishing marginal utility that the
total utility increases at a decreasing rate.
ii. Graphically
• In the figure, MUx is the marginal utility curve, which is
derived on the basis of an individual consumption of
successive units of good 'X'. MUx is downward sloping curve
which means successive goods 'X' goes on declining
throughout below the X-axis which indicates negative
utility.
• When the marginal utility is positive the total utility
increases at a decreasing rate by upward sloping portion of
the total utility curve TUx. Total utility is maximum where
the marginal utility is zero. At the 6th unit, marginal utility
becomes zero with the state of maximum satisfaction and
total utility of 6th unit is 30. When marginal utility becomes
negative, the total utility curve starts to fall by the
downward sloping portion of TUxcurve.
Relationship between TU and MU:
1. As TU increases at decreasing rate, MU
declines.
2. MU becomes zero when TU becomes
maximum.
3. MU becomes negative when TU starts to
decline.
 Importance of law of diminishing marginal
utility
• Guidelines for taxation
It guides the finance minister while formulating the
tax policy. A progressive tax policy, high tax for
high-income people and low tax for low-income
people, is based upon the marginal utility theory.
• Basic for price determination
When a marginal utility is at least equal to its price,
consumer desire to purchase the goods. The
consumer will pay a higher price for those having
higher MU and vice-versa.
 Cont……..
• Guidelines for the distribution of national wealth
The distribution of wealth and national income should be done
as per the guidelines of MU theory. Since, the demand of
rich people beyond certain has a diminishing utility whereas
if the government distribute the wealth to poor, it has
definitely a higher marginal utility.
• Basis for various laws in economics
Various laws in economics are based on a law of diminishing
marginal utility. For example, law of demand, a law of
substitution etc. These laws are derived from the law of
diminishing marginal utility.
 Cont……….
• Basis for consumer expenditure:
This law is important to regulate the
expenditure of the consumers. The consumer
has a limited amount of budget with them. So,
they do not waste budget by purchasing more
quanities. They stop their further purchase at
a point where MU equal to price
 LIMITATIONS OF THE LAW

The Law of Diminishing Marginal Utility is based on certain

assumptions. In most of the time, these assumption are applicable.
The law is not applicable in the case of the following situations:
• Irrational Consumers: 
  This law assumes that a consumer is a rational person. But, in reality,
most of the people are irrational because they use their income
without thinking.
• Cardinal Utility cannot be measured in number:
  This law is based on upon cardinal utility approach, in which differs
from person to person & it is not possible to measure it in exact
numbers.
 Cont……..
• Indivisible commodity:
  This theory is applied only for divisible goods. But in real life, there are
so many indivisible goods if divided into small units they loose utility.
• Doesn't apply to the basic goods:
  The law of diminishing marginal utility fails even to basic goods such
as food, clothes, air, etc. don't diminish from their additional unit of
consumption.
• Does not apply to the goods of entertainment:
  This law doesn't apply to the goods of entertainment like CD, TU, DVD,
etc because the use of such goods provides more satisfaction to the
consumers.
• Marginal utility of money is non constant
• Time gap
• Not homogeneous units
 How the Law of Diminishing Marginal Utility Can be Used to Explain the
Consumer’s Equilibrium?

• A consumer is said to be in equilibrium, when he

gets maximum utility out of his expenditure.
• Let a consumer with certain money income and
commodity X. Since both money income and
commodity X have utility for him, he can either
spend his money income on commodity X or retain
it in the form of asset. If MUx > Mum as asset,
utility maximizing consumer will exchange his
money income for commodity.
 Cont……..
• Thus, the consumer is in equilibrium, when
marginal utility and price are equal.
• In Fig. the consumer is in equilibrium at point ‘E’,
where MUx =Px (MUm) and he consumes OQ
units of the commodity.
• If he decides to consume less (say, OR units) or
more (say, OS units), there will be net loss of total
utility in both these situations indicated by shaded
areas GEF and HEI respectively in the figure.
• In the first case, the marginal utility, the
consumer will get is higher than the price he pays.
Cont………….
 Law of substitution/law of Equi-marginal
utility
a. Introduction
• Law of substitution is an important law in
economics.
• It is equally applicable in all parts of economics.
• This law was propounded by a famous economist
HH Gossen in 1854 AD.
• Therefore it is also called as Gossen’s second law.
Finally this law was fully developed by Alfred
Marshall.
 Cont……….
b. Statement:
• The law of substitution explains consumer
equilibrium in multi-commodity case.
• This law states that in order to maximize the
utility, the consumer allocates his/her money
income on various goods in such a way that
the ratio of marginal utility to price of each
goods be equal to the marginal utility of
money.
Cont………..
 Cont………
M=X.Px +y.PY
Where,
M= Money Income
X= good x
Y= Good Y
Px= price of X
Py= price of Y
 Cont…………..
c. Assumption:
This law is based on the following assumption:
• The consumer is rational.
• The utility can be measured in cardinal numbers.
• The marginal utility of money remains constant.
• No change in the price of goods.
• It is based on two commodity.
• Consumer has a given money income and has to spend
his whole income on consumption of selected goods
 Cont………
• Goods are divisible and all units of the
commodities are homogeneous
• Wants are comparable, substitutable and
complementary.
• Operation of the law of diminishing marginal
utility on consumption.
Tabular Explanation
 Cont………..
• As shown in above table, a consumer is in
equilibrium by purchasing 6th unit of good x
and 4th unit of good y.
• 24=6x2+4x3
• Mux/Px= MUy/Py= 5
Cont………………
 CONT……….
• As shown in graph , a consumer is in equilibrium by
purchasing 6th unit of good x and 4th unit of good y.
• Other combinations besides 6th unit of good x and
4th unit of good y will not maximize consumer's
equilibrium.
• For example, gain in utility by consuming one more
unit of good x is less than loss in utility by
consuming one less unit of good y which is shown
by shaded area.
 Importance of law of substitution

In consumption:
We know that the major objectives of the
rational consumer is utility maximization given
his income and prices of his goods. The law of
substation guides the consumers to select the
best combination of good by equalizing the
marginal utility obtained from various
commodities.
 Cont………
In production:
The major objective of all the producers is producing a
maximum amount of goods of minimum possible
costs. The producer always wants to maximize their
profit by selecting the best combinations of factor
input which provide the maximum possible output
for that, the producer substitutes one factor for
another till their marginal productivities become
equal (i.e MPc=MPk) and at that point total point,
total product becomes maximum.
 Cont………..
In exchange:
Law of substitution also guides in exchange as it is
related to purchase of goods by spending
money till marginal utility of goods become
equal to price. In other words,the law of
substitution also guides to determine the price.

 
 Cont……….
In distribution:
Distribution is the process of determining the
rewards of a factor of production land, labor,
capital and organization in the form of rent,
wages, interest, and profit. Such factor
payments are determined according to the
marginal productivity.
 Cont………..
In public finance:
Law of substitution is also equally important in
the field of public finance regarding the
revenue and expenditure pattern of
government. Government by imposing
progressive tax system enhances the welfare
of all as the burden of taxation falls equally to
all.
 Indifference curve
• A consumer possesses a definite scale of preferences
for goods and services.
• Each scale of preference includes a number of
alternative combinations of two or more goods,
which give the consumer the same amount of
satisfaction so that if he chooses any out of many
alternative combinations, he is neither better or
worse off.
• Therefore, he is found indifferent from these various
combinations.
• Such combinations of commodities are called
indifference combinations.
 Cont……….
• One can think of combinations of numerous
commodities which yield an equal level of
satisfaction to the consumers.
• For convenience, we can assume that there
are only two commodities under
consumption.
• An indifference curve is a locus representing
various combinations of two goods which
yields the same level of satisfaction to the
consumer.
 Assumptions of IC
1. The consumer must be rational.
2. Two wants are satiable at a time.
3. Ordinal measurement of utility.
4. The total utility depends on the quantities of the
commodities consumed. i.e U=f(q1,q2,…..qn)
5. Consumer has non-satiety in nature: the consumer prefers
more goods to less of it.
6. Consumer has scale of preferences
7. Operation of diminishing marginal rate of substitution
8. Consistency: if one period a consumer chooses bundle A
over B, he will not choose B over A in another period if both
bundles are available to him i.e.if A> B, then no B>A.
9. Transitivity: A>B @ B>C, then A>C
Indifference Schedule: A schedule of
various combinations of the two goods that will
give the same level of utility to the consumer.

Combinations x Y MRSxy
A 1 12 -
B 2 8 4/1
C 3 5 3/1
D 4 3 2/1
E 5 2 1/1
Indifference Curve: A graphical
representation of indifference schedule
 Cont………….
• In figure, IC is indifference curve which shows
that 1 of X and 12 of Y per unit of time
(combination A) gives the consumer the same
level of satisfaction as 2 of X and 8 of Y
(combination B) and so on.
Indifference Map: it is a set of indifference
curves
 Properties of Indifference Curve
1.IC always slopes downwards from left to
right:
• the negative slope of indifference curve shows
that two goods are substitutes for one other.
• This must be so if the level of satisfaction is to
remain the same on an indifference curve.
Cont……..
 Cont……..
• According to figure, any points lying on IC yield same
level of satisfaction i.e. TUA=TUB=TUC=TUD=TUE
• The consumer should sacrifice units of A in order to
get more units of B to maintain the same level of
utility.
• If the IC had slope of horizontal straight line or
vertical line or upwards to the right, the same level
of satisfaction is not obtained from any points lying
on such types of curves.
Cont……….
 Cont……….
2. IC convex to the origin:
• Due to diminishing MRSxy, IC is convex to the
origin.
• In figure, A to B (AP/PB)> B to C(BQ/QC) and
so on.
Cont………..
 Cont……..
3. Higher IC yields higher level of satisfaction
than lower one:
• It is because that the higher IC contains more
units of both goods or more units of at least
one good than lower IC.
• TU(IC3)> TU(IC2) >TU(IC1)
CONT………
 CONT………..
4. Indifference curves do not intersect each other:
• If two indifference curves intersect each other, it
would imply that an indifference curve indicates two
different levels of satisfaction or two different
combinations- one being larger than other- yield
same level of satisfaction.
• TU(IC1)=TU(IC2) at the intersect point. But TU(IC1)
>TU(IC2) at the left side of intersect point , whereas
TU(IC1)< TU(IC2) at the right side.
• This violets the assumptions of consistency and
transitivity.
Cont……..
 Marginal Rate of Substitution (MRS)

• It is the rate at which units of two goods are

substituted each other to maintain the same
level of satisfaction.
• MRSxy: MRS of X for Y represents the amount
of Y which the consumer has to give up for the
gain of additional units of X so that his level of
satisfaction remains the same.
• MRSxy= -∆Y/ ∆X= Mux/Muy= slope of IC
 Law of Diminishing Marginal Rate of
Substitution
• The MRSxy diminishes as a consumer substitutes more
and more units of X for Y goods.
• Causes:
1. Changes in intensity of want: As a consumer has
more and more of a good, the intensity for his wants
for that goods goes on diminishing. As a result, as the
individual substitutes more and more of x for y, he is
prepared to give up less and less of Y for a unit
increase in X.
2. Imperfect substitution:
 Budget Line
• A budget line is a locus representing various
combinations of two goods that can be purchased
by spending fixed income at a given prices.
Mathematically, the budget line can be written as:
M=Qx Px+Qy Py
Where, Px= price of X good
Py= price of Y good
Qx= quantity of X good
Qy= quantity of Y good
 Cont………………
Qx=M/Px-Py Qy/Px
Qy=M/Py-PxQx/Py
• If the consumer purchases only X goods by
spending entre budget (Qy=0), Qx=M/Px and
• if consumer purchases only Y goods by
spending entire budget (qx=0), then Qy=M/Py
• Slope of budget line= -Px/Py
Graphic ally
Shift in budget line due to change in price of
X keeping M and PY constant
Shift in budget line due to change in M
keeping Px and Py constant
 Consumer’s equilibrium
a. introduction
• A consumer’s equilibrium is defined as a point
where he has maximized the level of
satisfaction, given his income.
 b. Assumption
• Consumer must be rational.
• Consumer must have budget line and
indifference curve
• Prices of two goods remain unchanged
• Consumer has to maximize utility by spending
fixed budget.
 c.Conditions of consumer’s equilibrium

1. Necessary condition/ first order condition:

The budget line should be tangent to the indifference
curved
i.e slope of IC =Slope of budget line
(MRSxy=Px/Py)
2. Sufficient condition/second order condition
IC should be convex to the origin.
• It can be explained with help of IC and budget
line.
 Cont……………..
E= Consumer’s equilibrium (two conditions are
satisfied)
IC1=Not desirable because it gives lower level of
satisfaction than IC2 & IC3
IC3 = Desirable but unattainable due to budget
constraint
ON = Equilibrium quantity of Y
OM= Equilibrium quantity of X
• Consumer gets maximum satisfaction by spending
total budget on combination E which contains ON
units of Y goods and OM units of good X
• As higher satisfaction can be obtained from
higher IC than lower one, consumers tries to
attain equilibrium at IC3. however, any points
lying on such IC are unattainable. Hence he
cannot attain equilibrium at higher IC.
• Any points lying in IC2 yield lower level of
satisfaction because it contains less units of both
goods x and y or less unit of at least one goods.
Hence, cannot attain equilibrium at lower IC
 Price Effect
• Price effect shows the change in quantity
demanded for a commodity due to change in
its price, ceteris paribus(other things
remaining the same).
Price Effect on Substitutable Goods: There is a
positive relationship between price of one
commodity and demand for another one(i.e. as
price of x decreases, demand for Y decreases
and demand for x increases)
 Cont……….
• With given prices of goods X and Y, and a given
money income as represented by the budget line
PL1, the consumer is in equilibrium at Q on
indifference curve IC1.
• In this equilibrium position at Q, he is buying
OM1 of X and ON1 of Y.
• Let price of good X fall, price of Y and his money
income remaining unchanged. As a result of this
price change, budget line shifts to the position PL2.
 Cont……….
• The consumer is now in equilibrium at R on a higher
indifference curve IC2 and is buying OM2 of X and ON2 of Y.
• He has thus become better off, that is, his level of
satisfaction has increased as a consequence of the fall in
the price of good X.
• Suppose that price of X further falls so that PL3 is now the
relevant budget line.
• With budget line PL3 the consumer is in equilibrium at S
on indifference curve IC3 where he has OM3 of X and
ON3 of Y.
 Cont……….
• If price of good X falls still further so that budget line now
takes the position of PL4, the consumer now attains
equilibrium at T on indifference curve IC 4 and has OM4 of X
and ON4 of Y.
• When all the equilibrium points such as Q, R, S, and T are
joined together, we get what is called Price Consumption
Curve (PCC).
• Price consumption curve traces out the price effect.
• It shows how the changes in price of good X will affect the
consumer’s purchases of X, price of Y, his tastes and money
income remaining unaltered.
 Price Effect on Complementary Good: there is an
inverse relationship between price of one commodity
and demand for another (i.e as price of x decreases,
demand for both X and Y increases)
 Price effect on non-related goods: there is no relationship
between price of one commodity and demand for another. (as
price of X decreases, there is no change in demand for Y but
demand for x increases)
Price Effect on Giffen Goods: Such inferior good in which there
is a positive relationship between price of a commodity and its
demand.
 Income Effect
• It shows the change in quantity demanded for
a commodity due to change in income of the
consumer, other things remaining the same.
Income effect on normal gods: Normal goods are those goods in
which there is positive relationship between income and
demand (as income of the consumer increases, the demand for
both goods- say X and Y, increases and vice versa)
 CONT……….
• With given prices and a given money income as
indicated by the budget line P1L1, the consumer
is initially in equilibrium at Q1 on the
indifference curve IC1 and is having OM1 of X
and ON, of Y.
• Now suppose that income of the consumer
increases. With his increased income, he would
be able to purchase larger quantities of both
the goods.
 CONT……..
• As a result, budget line will shift upward and will
be parallel to the original budget line P1L2.
• Let us assume that the consumer’s money income
increases by such an amount that the new budget
line is P2L2(consumer’s income has increased by
L1L2 in terms of X or P1P2 in terms of Y).
• With budget line PA, the consumer is in
equilibrium at Q2on indifference curves IC2 and is
buying OM2 of X and ON2 of Y.
 CONT…….
• Thus, as a result of the increase in his income the
consumer buys more quantity of both the goods.
• Since he is on the higher indifference curve IC2he
will be better off than before i.e., his satisfaction
will increase.
• If his income increases further so that the budget
line shifts to P3L3, the consumer is in equilibrium
at Q3 on indifference curve IC3 and is having
greater quantity of both the goods than at Q2
 CONT……….
• If now various points Q1, Q2, Q3 and Q4 showing
consumer’s equilibrium at various levels of income are
connected together, we will get what is called Income
Consumption Curve (ICC).
• Income consumption curve is thus the locus of
equilibrium points at various levels of consumer’s
income.
• Income consumption curve traces out the income
effect on the quantity consumed of the goods.
• Income effect can either be positive or negative.
CONT………..
CONT……….
 Decomposition of Price Effect into
Substitution and Income Effects
PRICE EFFECT:
Other things remaining the same, the price effect shows the change in
quantity demanded for a commodity due to change in its own price.
Income effect:
Other things remaining the same, the income effect shows the change in
quantity demanded for a commodity due to change in income of the
consumer.
Substitution Effect:
The change in quantity demanded for a commodity due to change in its price
, with the level of utility held constant.
When the price of an item declines, the substitution effect always leads to an
increase in the quantity of the item demanded.
Decomposition of price
effect into income and
substitution effect in case
of normal goods
•Movement from e1 to e2=
=PE (Ox1 to OX2 )
(NEGATIVE)
•Movement from e1to e1’
= SE (Ox1 to OX1)
(NEGATIVE)
•Movement from e1’ to
e2= IE (0x1 TO 0x2)
(POSITIVE)
•PE= SE +IE
• x1X2= x1x1 + X1X2
 Explanation of Graph
Price effect:
• e1 is the initial equilibrium to the consumer
where AB budget line is tangent to the IC1.
• e1 equilibrium point shows that the consumer
consumes Ox1 units if X and e1x1 units of Y.
• Let price of X falls, other things remaining the
same, the budget line shifts rightwards from AB
to AB2’ due to the increase in purchasing power
of consumer for X good.
 Cont…………….
• The new budget line AB2’ is tangent to IC2 at
point e2 and the consumer reaches at his new
equilibrium. e2 equilibrium point shows that
he consumes OX2 units of X good and e2X2
units of Y good. Here, he increases x1X2 units
of X good and reduces e1x1-e2X2 units of Y
good. This process of adjustment on the
consumption of X and Y is called total price
effect. Price effect is negative.
 Cont………….
Substitution effect:
• Now this price effect can be decomposed into income
effect and substitution effect. In order to separate them
we remove the influence of the rise in real income caused
by the price change. We know that when the price of a
commodity falls the real income of the consumer goes up.
• PE=IE+SE
• Hicksian approach (compensating variation in income) is
used for that purpose.
•
 Cont…………….
• If this increased real income is taxed away the
budget line AB’2 will shift parallel to the downward
direction, so that relative prices are kept at their new
level. Here the money income of the consumer is so
reduced that the gain in real income due to a fall in
the price of X is eliminated.
• We have drawn the imaginary budget line MN
parallel to AB’2. The budget line is thus shifted to the
left in such a way that it is tangent to the initial
indifference curve IC1 at e1’.
 Cont……………..
• The movement from e1 to e1’ along the same
indifference curve, IC1, measures the
substitution effect of price change. Here, as X is
cheaper and Y is dearer, the consumer buys
more of X and less of Y. Thus, in quantitative
terms, x1X1is the substitution effect.
• Substitution effect is always negative due to
which the consumer buys more of X when its
price falls.
 Cont……………
Income effect:
• Now, we return the consumer’s increased money
income which had been taxed away earlier. The
budget line shifts parallel to AB’2 and the
consumer climbs up to a higher indifference curve
IC2 and equilibrium occurs at point e2. The
movement from e1’ to e2 is, thus, the income
effect which enables the consumer to buy more of
X, that is, X1X2. Here, the income effect is positive.
 Decomposition of price effect into Income and
Substitution Effects: Inferior Good
Clothing
(units per As food is an inferior good
month) in this example, the income
R effect is negative. However,
the substitution effect is
larger than the income effect.
A
B

U2
D

Substitution
Effect U1
Food (units
O F1 E S F2 T per month)
Total Effect
Income Effect

Chapter 4 Slide 96
Decomposition of Price
Effect into Income and
Substitution effect in
case of Giffen goods
•The income effect is
negative. However,
income effect is greater
than substitution effect.
•Movement from R to
T= PE
•Movement from R to H
= SE
•Movement from H to
T= IE