Decomposing a price change into substitution and income effects (Hicksian decomposition)
Parameters
Original Price of X (Px1)2.00
New Price of X (Px2)4.00
Price of Y (Py)2.00
Income (M)100
Preference weight (α)0.50
Step-by-Step
Bundles
A (Original)—
B (Compensated)—
C (New)—
Substitution Effect (ΔX)—
Income Effect (ΔX)—
Total Effect (ΔX)—
Legend
Original BL
New BL
Compensated BL
Point A
Point B
Point C
How It Works
When the price of X changes, the consumer adjusts their bundle. This total change can be split into two parts:
Substitution Effect (A→B): Holding utility constant, the consumer substitutes toward the relatively cheaper good. We find B by asking: at the new prices, what bundle achieves the original utility at minimum cost?
Income Effect (B→C): The price change also changes real purchasing power. Moving from the compensated budget to the actual new budget shifts consumption of both goods (for normal goods).
Adjust sliders to change prices & see effects · Use step buttons to walk through the decomposition