Answer to Question #100817 in Microeconomics for Damilola

Question

Use appropriate diagrams to illustrate the income and substitution effects of a price on the demand for an inferior good.

Answer 1

In a situation of inferior good, the income effect works opposite direction towards substitution effect. When prices of the inferior goods fall, their negative income effect tends to decline the quantity bought and on the other hand the substitution effect tends to increase the quantity bought as illustrated in graphs 1 and 2 below:

Figure 1: Price effect split up into substitution and income effect of a price demand of the inferior good.

Figure 2: Price-Demand Relationship in Inferior goods.