Only two goods x and y, are available. The price of x increases (but the price of y and income stay the same). It's seen that the quantity of x increases and the quantity of y decreases. Standard preferences (e.g monotonicity) apply.
a. Is good x a normal good, inferior good, or can’t tell? Explain.
b. Is good y a normal good, inferior good, or can’t tell? Explain.
c. Is good x a complement to good y, a substitute for good y, or can’t tell? Explain.
a. x is an inferior good
The price of x has increased and as a result, quantity of x has increased. The demand for x has a positive relationship with the price. So, x is a giffen good. All giffen goods are inferior goods. So, x is an inferior good.
b. y is a normal good.
The price of x has increased and income has stayed constant. It means that the purchasing power of the individual has decreased. It means the real income has fallen.
Real income has decreased and demand for y has decreased. Therefore, y is a normal good.
c. x is a substitute for good y.
As a result of price change, the individual decreases the consumption of y and increases the consumption of x. It means that x is being substituted for y.
So, x is a substitute for y.
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