Answer to Question #105180 in Microeconomics for Mulweli Mukutu

Question

Consider a consumer's choice of fish and meat. Use indifference curves to illustrate the income effects and substitution effects of an increase in the price of fish (10 marks).

Answer 1

Let X - fish, Y - meat.

The allocation of the income effect is achieved by determining its level that would provide the consumer with the opportunity to purchase the same set of goods after changing prices as before the change.

The budget line KL corresponds to cash income I and prices Px and Py. Since fish is presented as product X, we consider the conditions following the increase in the price of product X.

Auxiliary budget direct KL, parallel to KL1, not tangential to the previous indifference curve U1,

but strictly through the point Е1 corresponding to the optimal set of goods X and Y with the same price ratio.

The overall result of increasing the price of goods X (X1 - X3) is decomposed into the replacement effect (X1 - X3) and the income effect (X3 - X2)/