Answer to Question #109310 in Microeconomics for Someswari A/P S. T. Rajan

Question

Consider a consumer's choice between meat and fish. Use indifference curves to illustrate the income effect and substitute effect of an increase in the price of fish.

Answer 1

X= Fish, Y= Meat

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)