Micro · 01
Utility & Indifference Curves
The indifference curve framework decomposes the effect of a price change into two components — the substitution effect and the income effect. Mastering this decomposition, and understanding how it differs across normal, inferior, and Giffen goods, is essential for Paper 3 and Paper 4.
6 Animated Diagrams
Hicksian Decomposition
Normal · Inferior · Giffen
Paper 3 & Paper 4
Normal Good
For a normal good, both the substitution effect and income effect move in the same direction — reinforcing each other. A price fall increases demand; a price rise reduces it. The demand curve slopes downward.
Inferior Good
For an inferior good, the income effect works against the substitution effect — but the substitution effect wins. Demand still moves in the expected direction, just by less. Classic examples: own-brand staples, budget transport.
Giffen Good
The Giffen paradox — the income effect is so powerful it completely overwhelms the substitution effect. A price fall reduces demand; a price rise increases it. The demand curve slopes upward. Theoretically fascinating, empirically extremely rare.
Key Concepts
Definitions you must be able to produce precisely in an exam.
Substitution Effect
The change in quantity demanded due solely to the change in relative price, holding real income constant (moving along the same indifference curve). Always moves toward the relatively cheaper good.
Income Effect
The change in quantity demanded due to the change in real purchasing power caused by the price change. Positive for normal goods, negative for inferior goods.
Normal Good
A good for which demand increases as real income rises. Both SE and IE reinforce each other. Income elasticity of demand is positive.
Inferior Good
A good for which demand falls as real income rises. The IE partially offsets the SE but does not dominate it. Income elasticity of demand is negative.
Giffen Good
A special case of an inferior good where the negative IE is so large it completely overwhelms the SE. Demand falls when price falls. Upward-sloping demand curve. Income elasticity is strongly negative.
Compensated Budget Line
A hypothetical budget line with the new price ratio but adjusted income so the consumer can just reach the original indifference curve. Used to isolate the substitution effect. Parallel to the new budget line.
Exam Technique
What separates a Level 3 answer from a Level 4 on this topic.
Paper 3 & 4 — Indifference Curves
01Always draw the compensated line parallel to B₂. This is the most common diagram error. The compensated line must have the same slope as the new budget line — not the same slope as the original. If it isn't parallel, your E₂ is in the wrong place and your whole decomposition collapses.
02State the sandwich explicitly. For inferior goods: E₁ < E₃ < E₂. For Giffen goods: E₃ < E₁ < E₂ (price fall) or E₂ < E₁ < E₃ (price rise). Writing this out shows the examiner you understand the geometry, not just memorised a shape.
03The SE is always "normal". Even for Giffen goods, the substitution effect always moves toward the cheaper good. The Giffen paradox is entirely about the income effect dominating. Never say the SE is reversed.
04Label all three equilibria clearly — E₁, E₂, E₃ — and indicate on the x-axis which direction each effect moves. Drop perpendicular dotted lines to the axis. Examiners are marking your diagram as much as your words.