9. Income and substitution effects Lorenzo and Neha Stewart live in Houston and

Question

9. Income and substitution effects Lorenzo and Neha Stewart live in Houston and enjoy going out to fancy restaurants for dinner and to diners for breakfast. On the following diagram the purple curves Ii and I2 represent two of their indifference curves for fancy dinners and diner breakfasts. They have $800 per month available to spend on eating out. The price of a diner breakfast is always $10. Each labeled point represents the tangency between a budget constraint and the corresponding indifference curve 0 48 40 26 I BC 10 FANCY DINNERS

Explanation / Answer

Income spent on fancy dinners and breakfast diners would now only be 5 * 40 + 26 * 10 = $460,This is the income level represented by the blue budget constraint which is parallel to the new budget line BC2.

Better off as consumption of both goods increases.

Substitution effect of fancy dinners is represented by movement from X to Y.The consumption change is 5.2 = 3 units.

The income effect is represented by movement from Y to Z and the consumption change is 10-5 = 5 units.

Increase

Normal goods. This is because increase in real income leads to increase in quantity demanded of fancy dinners.

Related Questions

Navigate

• Browse (All)
• Browse 9
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.