Question

for each case, explain the direction of the substitution effect, income effect and total effect.

- the price of good x, a normal good, increases

- the price of good y, an inferior good, increases

Answer 1

1. If the price of good X, a normal good, increases.

Total Effect = Substitution Effect + Income Effect

Substitution effect would be negative. Income effect would also be negative. Total effect would, therefore, be negative.

2. The Price of Good X, an Inferior good, Decreases.

Substitution effect would be negative. Income would be positive. Total effect would, therefore, be negative.

3. The price of good X, a Giffen good, increases.

Substitution effect would be positive. Income effect would be positive. Total effect would, therefore, be positive.