Question

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.

Answer #1

When the price of a normal good decrease, real income (M/P) increases so people demand more. This is called income effect that is demand for the normal good is increased for increased purchasing power.

Substitution effect means when the price of a normal good deceases people will substitute other expensive goods with that cheaper good.

the income and substitution effects of a price change
explain what

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(a) State Amy’s optimization problem. What is the objective
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(b) Draw the Amy’s budget constraint. Place chocolate on the
horizontal axis, and ”expenditure all other...

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certainty?
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2. The income and substitution effects will reinforce one
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each other, and label the point at which the curves cross.
Suppose now that the price of candy increases to $5. Show on the...

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