Suppose that when the price of X goes up, you respond by consuming less Y . a) I

Question

Suppose that when the price of X goes up, you respond by consuming less Y .

a) Illustrate the substitution and income effects of an increase in the price of X. How

does your graph illustrate the information in italics above?

b) Is Y a normal good or an inferior good? Carefully explain how you can tell.

c) Looking at the effects on your consumption of Y , which is bigger—the income effect or the substitution effect? Carefully explain how you can tell.

Please be sure to note that parts (b) and (c) ask about Y , not X.

Explanation / Answer

imagine a graph having goods at both the axis with limits X=0 to 30 Y= 0 to 20. there are three slopes A(16,6), B(8,10) and C(13,18) and two indiffrence curve.

The price of good Y has risen because the budget line moves in. Since the intercept indicates I/Py, Py²/Py¹ = (I/Py¹) / (I/ Py²)

a) The substitution effect is shown by the movement from A to C. The income effect is C to B. The price effect is A to B.

b) Both of good X and Y are normal since both income effects are negative in response to income decline

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