PRICE EFFECT

as a combination of
SUBSTITUTION
and
INCOME EFFECT
Substitution Effect
• Maximum utility is subject to income and prices
• PxQx + PyQy = M
This is budget constraint
• The consumer is in equilibrium when
MRS=Px/Py
Where would the consumer’s optimal choice be if they had to be on
Original Indifference curve?
10

8
C

6
A
B
4

2 4 6 8 10