Question

Using consumer theory, consider how households may respond to having their budgets squeezed as a result of the increase in prices of food, housing and energy. Make particular reference to and isolate any substitution and income effects (hint: you could make use of composite goods). A good place to start is to consider what type of goods these goods/services are, for example, whether they are normal or inferior goods; luxuries or necessities; and consider how your answer may vary with different income levels.

Answer 1

Answer : According to consumer theory , consumers are satisfied with highest utility where budget line and indifference curve are tangent to each other. We know that in case of necessary goods if price rises then deman remains same, in case of luxury goods demand varies , it is depending on consumer's income level , in case of normal goods if price rises then demand decreases , in case of inferior goods if price rises then demand increases.

Given that price rises of food, housing and energy. These are the basic needs of human beings. Therefore, these are necessary goods and hence if price rises then it has no impact on demand. In this case because of limited budget for households they decrease their other consumptions.