Income and Substitution Effects for Mean-Preserving Spreads

Abstract

A. 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. Copyright 1989 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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