Question

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 by referring to the income and substitution effects that will occur. (5)

As a result of this price change, will the quantity of good X increase, decrease or will the direction of change be ambiguous? Support your answer by referring to the income and substitution effects that will occur. (5)

Answer 1

In the figure the blue budget line is shown concave shape.Budget line should be always a straight line sloping
downwards.
(a):In the question its is given good X is inferior and good Y is normal.Now when the price of the normal good increases the demand for the normal goods also decreases as there is a negative relationship between the price and quantity demanded in case of the normal goods..Here there is no change in the budget constraint as the income remains the same.When the price of good y increases the quantity demanded of good y will decrease and the quantity of good x decreases.For inferior goods there is negative relationship between the income and demand of goods.
In the case of normal goods income effect dominates the substitution effect.In the case of inferior goods the income effect is negative and the substitution effect dominates