Question

1) Suppose there are 2 goods, x1 and x2. The price of x1 goes up. x1 is inferior, and x2 is normal. Using income and substitution effects, show which of the claims below is correct.

	the quantity of both goods will go down
	x1 will decrease in quantity, but x2 will go up
	the quantity of both goods will go up
	x1 may increase or decrease in quantity, the same is true for x2

2) Suppose there are 2 goods, x1 and x2. The price of x1 goes up. x2 is inferior, and x1 is normal. Using income and substitution effects, show which of the claims below is correct.

	The quantity of x1 will go up. The quantity of x2 will go down
	There is not enough information to answer the question
	The quantity of both goods will go down
	The quantity of x1 will go down. The quantity of x2 will go up.

Answer 1

Answer 1: x1 will decrease in quantity, but x2 will go up

Reason: As the price of inferior good goes up, the quantity demanded will go down because if it's price comes close to the normal good, people buying inferior good due to lesser price will substitute it for normal good. Resulting in an increase in x2 quantity.

Answer 2: The quantity of x1 will go down. The quantity of x2 will go up.

Reason: People with the same income level will not be able t purchase the normal good due to an increase in its price, and those people will substitute the same good for an inferior good resulting in an increase in demand for the inferior good.