Income and Substitution Effects for Mean-Preserving Spreads

Sandmo has ascribed the indeterminancy of the comparative static result for a mean-preserving spread to the presence of both an income and a substitution effect. In this note the compensation method needed to isolate the substitution effect identified by Sandmo is made precise. The compensation meth...

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Bibliographic Details
Published in:International economic review (Philadelphia) 1989-02, Vol.30 (1), p.131-136
Main Author: Davis, George K.
Format: Article
Language:English
Subjects:
Ambiguity
Compensation
Competitive firms
Consumer expenditure
Consumption
Consumption theories
Economic models
Economic theory
Economic uncertainty
Effects
Expected utility
Income
Income effect
Mathematical analysis
Random variables
Standard deviation
Substitution
Substitution effect
Two period model
Utility functions
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Summary:Sandmo has ascribed the indeterminancy of the comparative static result for a mean-preserving spread to the presence of both an income and a substitution effect. In this note the compensation method needed to isolate the substitution effect identified by Sandmo is made precise. The compensation method is derived from a model that is sufficiently general to include many important applications of the theory of uncertainty. The method is used to identify the substitution effect in Sandmo's model of the competitive firm under output price uncertainty.
ISSN:0020-6598
1468-2354
DOI:10.2307/2526553