Answer to Question #211061 in Microeconomics for Arwah Bashir

Question

Q4) a) Assuming that food is a normal good up to a certain level of income, show that an increase in price would

induce the substitution and income effects to move in the same directions. What would be the total effect on the

quantity of food.

b) Assuming that food is inferior up to a certain level of income, show that an increase in price would induce the

substitution and income effects to move in the opposite directions. What would be the total effect on the quantity of

food.

Answer 1

Solution:

Q4). a). Normal goods refer to items whose demand will increase if there is an increase in consumer income and vice versa. The substitution and the income effect will move in the same direction as a result of price changes for a normal good. Therefore, the increase in the price of food, which is a normal good, will cause consumers to substitute more of other goods, whose prices are relatively lower resulting in a decrease in food demand and an increase in demand for substitute goods. Similarly, consumers' purchasing power will also be reduced by the higher price, causing them to reduce food consumption through the income effect, hence reducing the demand for food.

The total effect on the quantity of food is that food demand will decrease massively due to income and substitution effect moving in the same direction to limit food demand as a result of the price increase. Both the income and substitution effect will decrease the food demand.

 

b.). Inferior goods refer to items whose demand will fall when there is an increase in consumer income and vice versa. The substitution and the income effect will move in the opposite direction as a result of price changes for an inferior good. As such, the increase in food price, which is an inferior good, the substitution effect will cause the consumers to purchase less of the said food, while the income effect will dominate the substitution effect and cause consumers to purchase more food, increasing its demand.

The total effect on the quantity of food is that food demand will decrease slightly due to income and substitution effect moving in the opposite direction to limit food demand as a result of the price increase. The substitution effect will decrease food demand, while the income effect will increase food demand.