Hicksian Decomposition essay

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Substitution effect

The consumer moves along the same indifference curve.

The substitution effect is isolated by drawing a hypothetical budget line parallel to the original budget line such that the consumer now consumes at point F where the hypothetical budget line is tangent to the original indifference curve U1

Income effect

The consumer moves to a new indifference curve BL1

The consumer shifts from point F where the hypothetical budget line is tangent to the original indifference curve to a new indifference curve in the pivoted budget line

The consumer equilibrium shifts from point F to point B

Transport is a normal good since the rise in the price of good reduces consumer’s real income. The consumer tends to buy less and less of that good (transport) income effect pushes the equilibrium consumption further right from F to B.

If transport was an inferior good the income effect would not have pushed the budget line further right. It would have pushed the consumption bundle F leftward to somewhere between Point B and A.

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