Based on the graph below, answer the following questions. Be sure to justify you

Question

Based on the graph below, answer the following questions. Be sure to justify your answer using the information in the graph. Briefly describe how you can use points A, B, and C to determine the income and substitution effects of the decrease in the price of X. Basically, walk through the "thought experiment" from lecture. What's the economics of the dotted line? What does it tell you? Based on this picture, make a table that shows the direction of how X and Y change (i.e. arrows) because of the substitution effect and the income effect, and how these add up to the total change in X and Y. Are X and Y substitutes or complements? How do you know? Are X and Y normal goods or inferior goods? How do you know?

Explanation / Answer

Point A is the original optimizing bundle; it lies on the original budget constraint. The decrease in the price of good 1 rotates the budget line outward, holding the x2 intercept ?xed. Point B is the bundle this consumer would choose if, in response to the decline in the price of good 1, we reduced income just enough so that the consumer could just a

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