Although this is the most common way to impose the assumption in developing a ceteris paribus demand curve, it is not the only way. An alternative approach holds constant while examining reactions to real income (or utility) changes in The derivation is illustrated in Figure 6. There we hold utility constant (U2) while Px. successively reducing As falls, the individual's nominal income is effectively reduced, Px. Px thus preventing any increase in utility. In other words, the effects of the price change on purchasing power are "compensated" so as to constrain the individual to remain on U2. Reactions to changing prices include only substitution effects. If we were instead to examine effects of increases in income compensation would be positive: This individual's income Px, would have to be increased to permit him or her to stay on the indifference curve in response U2 to the price rises. We can summarize these results as follows: FIG 6 Construction Of a compensated demand curves
Although this is the most common way to impose the ceteris paribus assumption in developing a demand curve, it is not the only way. An alternative approach holds real income (or utility) constant while examining reactions to changes in Px. The derivation is illustrated in Figure 6. There we hold utility constant (U2) while successively reducing Px. As Px falls, the individual's nominal income is effectively reduced, thus preventing any increase in utility. In other words, the effects of the price change on purchasing power are "compensated" so as to constrain the individual to remain on U2. Reactions to changing prices include only substitution effects. If we were instead to examine effects of increases in Px, income compensation would be positive: This individual's income would have to be increased to permit him or her to stay on the U2 indifference curve in response to the price rises. We can summarize these results as follows: FIG 6 Construction Of a compensated demand curves