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.

Rick purchases two goods, food and clothing. He has a
diminishing marginal rate of substitution of food for clothing. Let
x denote the amount of food consumed and y the amount of clothing.
Suppose the price of food increases from Px1 to Px2. For which of
the following cases the price effect equals the substitution
effect?
A.Food is a normal good.
B.Food is neither a normal good nor an inferior good.
C.The income elasticity of demand for food is zero....

When the price of an inferior good falls, the substitution
effect contributes to a(n) _____ in the quantity demanded, and the
income effect _____ the substitution effect.
decrease; reinforces
decrease; opposes
increase; reinforces
increase; opposes
I know that the substitution effect will cause an increase in
the quantity demanded. However, does the fact that it is an
inferior good effect it? Also, the would the income effect
reinforce the substitution effect?

In decomposing the total effect of a price change into income
and substitution, we can solve it using consumer optimization.
Utility U=XY+20X and total income is $200. Original price of X,
Px=$4 and price of good Y, Py=$1. The original optimal bundle is
(X=27.5, Y=90). Then the price of X decreases to $2. And the new
optimal consumption is (X=55, Y=200). Write out the Lagrange for
the expenditure minimization problem solving for the optimal bundle
at the new prices and...

Suppose that a consumer consumes
only two goods, coconuts and bananas. Suppose that the price of
bananas increases.
A) Explain the direction of the income effect and substitution
effect for both goods if both goods are normal goods.
B) What we say about the total change in the consumption of
bananas if a banana is an inferior good?

Questions 8-10 are parts of this question:
Suppose good X is inferior and good Y is normal, and the price
of good Y increases (income and the price of good X remain
unchanged).
a) Describe how the consumer’s budget constraint will change.
(Hint: drawing the new and old budget constraints should help you).
(2)
As a result of this price change, will the quantity of good Y
increase, decrease or will the direction of change be ambiguous?
Support your answer...

price of x fall x is giffen good. Draw a graph showing
income and substitution effect

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...

Explain in words, in one paragraph, what the income and the
substitution effects of a price decrease are. Then show in a
diagram the income and substitution effects of a price decrease for
a normal good. Label your diagram carefully, and explain in a
couple of sentences what the diagram shows.

2. Answer true, false, or it depends. Explain your answer using
indifference curve analysis for a, b, and e, and using the formula
for price elasticity of demand for (c) and (d).
a- Suppose that X and Y are perfect substitutes,
MRSxy = 3, Px = $4, Py = $2, and I
= $10. Then, the consumer will spend all her income on good Y,
purchasing 5 units.
b- For an inferior good, the substitution and income effects
work in...

Use
the concepts of income effect and substitution effect to explain
why the effect on desired saving of an increase in the expected
real interest rate is potentially ambiguous. (For full credit, make
sure you differentiate between borrowers and savers) Draw the
saving curve for when (a) substitution effect dominates (b) income
effect dominates (Make sure you label the axes)

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