Question

5 Explain what would happen to the equilibrium consumption of two goods, X and Y, if:

1. Income doubled and all prices tripled, or;
2. All prices doubled and income tripled, or;
3. All prices and income doubled.

Assume that Goods X and Y are both normal goods. You are welcome to draw a graph for each outcome if you wish.

Answer 1

A.An increase in income shifts the budget line parallel to right and an increase in price of both goods shifts budget line to the left.An increase in income increases purchasing power and an increase in price reduces purchasing power.

But since the increase in price is greater than the increase in income,the budget line will shift to the left.The consumption of goods will fall.

B.In this case the rise in income is greater than the rise in price.Thus,budget line will shift to the right . Consumption of goods will ris

C.No change because increase in price=increase in income.

The original budget line is AB.

A shifts budget line from AB to A""A""

B shifts budget line from AB to A'B'