No Service 12:21 PM courses.aplia.com 9. Income and substitution effects Giberto

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No Service 12:21 PM courses.aplia.com 9. Income and substitution effects Giberto and Janita hones ive in Dallas ond eroov out totancy restaurants rer armer and to arw, treatat the folemng aagren, the purple curves 1, and 12 reperesent two of their inditterence curves for fancy dinners and diner breasifests. They have $000 per month available to spend out. The price of a diner breakfast is always $10. Each labeled point regresents the tangency between a budget constraint and the corresponding indfference curve FANCY DINNERS The initial budget constraint (BC shows the Joneses' budget constraint when the price of a fancy dinner is $160. A this price, Giberto and Juanita would choose to consume two fancy dinners Sopose that the price offancy dinner decreases to 140, shring he adjr ooniraithac breaifasts per fancy dinner. (Hint: The blue šne labeled H is paralilel to 8C and tangent to , at point s In order to remain as happy as they were before the price decrease-chat is, to consume at some point on the same indfference ourve which represents a new relative price of four diner as they were onintiaay(11)-- Joneses, income spent on fancy diners and breakfast at dners would mow any have to be However, in reality, rather than maintaining their aniginal level of uuty, the Jeneses choose the optimal bundle along ther new budget constraint. At this peint, they are off than before the price dange infancy amen On the folowing table, indicate which point movement represents the from $160 to $40. Then indicate the consumption change that resuits from each effect substitution efflect and income efflect for fancy dinners when the price decreases Consumption Change Fancy Dinners Represented By.. (Quantity of fancy dianers) Income Effect In this case, the price decrease of fancy dinners causes the Joneses's real income to real income and the direction of the income efflect, fancy dinners are . Because ofthe d ange to Gilberto and Ju for the Joneses

Explanation / Answer

If they need to be on the initial indifference curve, they consume at point S with 5 fancy dinners and 26 diner breakfast. Price of fancy dinners is 40 and price of diner breakfast is 10. So income = 40*5 + 10*26= 460.

In reality they consume at point T which is rightwards to initial allocation point. So they are better off.

S represents substitution effect and fancy dinners consumption increases

T represents income effect and consumption of fancy dinners increases.

Because of the fall in prices real income increases.

Fancy dinners are normal for them.

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