As before, we can rule out those portions of the compensated budget constraint which lie under the original budget constraint. She won't choose these bundles as they were available when she chose A.

    Suppose she chooses C on the compensated budget, consuming DC DVDs. Since DVDs are normal goods both the income and substitution effects work in the same direction, to increase consumption when price falls.
DO - DN is the total change in demand.
DO - DC is the substitution effect.
DC - DN is the income effect.

Copyright © 1995-2004, Inc. - All Rights Reserved