Slutsky equation

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In microeconomics, the Slutsky equation (or Slutsky identity), named after Eugen Slutsky, relates changes in Marshallian (uncompensated) demand to changes in Hicksian (compensated) demand, which is known as such since it compensates to maintain a fixed level of utility. There are two parts of the Slutsky equation, namely the substitution effect and income effect. In general, the substitution effect is negative. Slutsky derived this formula to explore a consumer's response as the price of a commodity changes. When the price increases, the budget set moves inward, which also causes the quantity demanded to decrease. In contrast, if the price decreases, the budget set moves outward, which leads to an increase in the quantity demanded. The substitution effect is due to the effect of the relative price change, while the income effect is due to the effect of income being freed up. The equation demonstrates that the change in the demand for a good caused by a price change is the result of two...

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