ne to Statistics Canada, the average retail prü a litre of regular gasoline in R

Question

ne to Statistics Canada, the average retail prü a litre of regular gasoline in Regina. Sask ose from S0 547 in 1900 to $1.217 in 2011, a Other things equal, describe theeffect of this your explanation, make use of the utility-m and substitution effects f this price increase on the quantity of gasoline desmanded. In make use of the utility-maxin ribe income principle of marginal analysis and describeinc In In fact, however, other things were not equal. Over the same time period, the prices of other goods a services rose as well. According to Statistics Canada. the overall price of a bundle of goods and services con- sumed by an average consumer in Regina rose by 63% s of other goods and (from 1990 to 2011) b. Taking into account the rise in the price of gasoline and in overall prices, other things equal, describe the effect on the quantity of gasoline demanded. However, this is not the end of the story, Between 1990 and 2011, the typical consumer's nominal income increased, too: Statistics Canada reports that in Saskatchewan, average household nominal alter-tax and transfer income rose from $30 300 in 1990 to $47 100 in 2011, an increase of 55%. c. Taking into account the rise in the price of gaso- line, in overall price describe the effect demanded ind in consumers incomes tity of gasoline

Explanation / Answer

Part(a) - Utility maximizing principle of marginal analysis says that Marginal utility per dollar spent on each good must be same in the optimal consumption bundle.Say for any two goods A and B,at the optimal consumption bundle, MUA/PA=MUB/PB.

In this question ,price of a litre of gasoline rises by 122%. This price increase will not change the Marginal utility consumer get from additional unit of gasoline ,that is MUGASOLINE.But it changes marginal utility per dollar spent on gasoline.So consumer will consume less gasoline when price of gasoline rises(other things being equal).So quantity demanded of gasoline decreases.

According to substitution effect,consumer move his choices to relatively cheaper good after price changes.Since price of gasoline rises, it became relatively expensive,so consumer consume less of gasoline.

Income effect says change in quantity demanded due to change in consumer's purchasing power resulting from change in price of a good.Since consumer's real income falls leading to decrease in purchasing power,so this decrease in real income leads to reduction in quantity demanded.

Part(b)- Price of other goods rose by 63% along with price rise of gasoline.Since price rise of gasoline is more than price rise of other goods,MUGASOLINE/PGASOLINE<MUOTHER GOODS/POTHER GOODS.Consumer will reallocate his spending on other goods because that will increase his total utility.Hence quantity demanded of gasoline decreases.

Part(c) - Household nominal income rose by 55%.Real income may either decrease or increase depending on price change.If prices of all goods rose by more than 55%,real income will fall leading to reduction in quantity demanded.

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