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Root Beer

Root Beer. A. •. B. •. •. C. D. •. •. E. •. Quinine Water. A-B: Irrational Behavior B-C: Positive Price Effect (Giffen Good) C-D: Negative Price Effect / Gross Complements D-E: Negative Price Effect / Gross Substitutes. Root Beer. Quinine Water. (a) Initial Experiment.

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Root Beer

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  1. Root Beer A • B • • C D • • E • Quinine Water A-B: Irrational Behavior B-C: Positive Price Effect (Giffen Good) C-D: Negative Price Effect / Gross Complements D-E: Negative Price Effect / Gross Substitutes

  2. Root Beer Quinine Water (a) Initial Experiment (c) Price Experiment (b) Income Experiment

  3. Units of Measure • Price = $ / unit • Presses are rat $ • Serving size per press = units / $ = 1 / Price • .05 cc/press => 20 presses / unit • .1 cc/press => 10 presses / unit • .15 cc/press => 6.7 presses /unit

  4. Income Effect

  5. Price Effect

  6. Negatively Sloped Demand Curve Price Q(P, Income=110) (b) (a) • • (c) • Q(P, Income=60) Consumption

  7. Linear Demand Function Q = 10.1 - 0.63 Price + .03 Income

  8. Income Effect

  9. Price Effect

  10. Positively Sloped Demand Curve Price Q(P, Income=110) (a) (b) • • (c) Q(P, Income=75) • Consumption

  11. Is the Rat Rational? What Does it Mean?

  12. Root Beer Irrational (a) • (c) • • (b) Quinine Water Rational

  13. Is the Rat Rational? How Can We Tell?

  14. Slutsky Equation Price Effect + Income Effect Weighted by Consumption = Substitution Effect Substitution effect must be negative.

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