Author
Abstract
Visible substitutions between goods as a result of a price change have to occur insofar as the price elasticity of demand deviates from unity. A price-elastic demand leads to a larger expenditure share after a price decrease. This implies that the aggregate expenditure share for all other goods, including money in one's cash balance, has to decrease. A visible substitution takes place as the demand for other goods is reduced. Similarly, a price-inelastic demand for a specific good leads to a larger expenditure share after a price increase. The aggregate expenditure share of all other goods has to decrease and the consumer reduces demand for at least one other good. By following the expenditure approach to income and substitution effects it is shown that the conventional analysis of deadweight loss from taxation is misleading. The deadweight loss is underestimated when demand is inelastic and overestimated when it is elastic. Visible substitutions between goods as a result of a price change have to occur insofar as the price elasticity of demand deviates from unity. A price-elastic demand leads to a larger expenditure share after a price decrease. This implies that the aggregate expenditure share for all other goods, including money in one's cash balance, has to decrease. A visible substitution takes place as the demand for other goods is reduced. Similarly, a price-inelastic demand for a specific good leads to a larger expenditure share after a price increase. The aggregate expenditure share of all other goods has to decrease and the consumer reduces demand for at least one other good. By following the expenditure approach to income and substitution effects it is shown that the conventional analysis of deadweight loss from taxation is misleading. The deadweight loss is underestimated when demand is inelastic and overestimated when it is elastic. Visible substitutions between goods as a result of a price change have to occur insofar as the price elasticity of demand deviates from unity. A price-elastic demand leads to a larger expenditure share after a price decrease. This implies that the aggregate expenditure share for all other goods, including money in one's cash balance, has to decrease. A visible substitution takes place as the demand for other goods is reduced. Similarly, a price-inelastic demand for a specific good leads to a larger expenditure share after a price increase. The aggregate expenditure share of all other goods has to decrease and the consumer reduces demand for at least one other good. By following the expenditure approach to income and substitution effects it is shown that the conventional analysis of deadweight loss from taxation is misleading. The deadweight loss is underestimated when demand is inelastic and overestimated when it is elastic.
Suggested Citation
Karl-Friedrich Israel, 2022.
"The expenditure approach to income and substitution effects,"
Economics Bulletin, AccessEcon, vol. 42(2), pages 431-446.
Handle:
RePEc:ebl:ecbull:eb-21-00257
Download full text from publisher
Corrections
All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ebl:ecbull:eb-21-00257. See general information about how to correct material in RePEc.
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
We have no bibliographic references for this item. You can help adding them by using this form .
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: John P. Conley (email available below). General contact details of provider: .
Please note that corrections may take a couple of weeks to filter through
the various RePEc services.