Answer to Question #249038 in Microeconomics for SHREYA

Question

A famous university in South Delhi is composed of a large poor class and a minority wealthy class of students. Each student in this university buys only two goods: new economic books and used economics books.

For each poor consumer, the income effect of a change in the price of used books reinforces the substitution effect – both are in the same direction. For each wealthy consumer, the income effect opposes and outweighs the substitution effects.

a) Think about what could cause the income effects of the two classes to be different. Explain

b) Illustrate graphically the effect of a decrease in the price of used books on an individual’s consumption in each class (poorer and wealthier students). Label the substitution and income effects for used books. 

Answer 1

Solution:

a.). The reason why income effects of the two classes are different is that used economic books are a normal good to the poor class and new economic books are inferior Giffen goods. A normal good is where a change in income leads to a change in quantity demanded. That is when income rises, the quantity demanded increases. A Giffen good is a good whose demand falls as income increases.

 

b.). The effect of a decrease in the price of used books on an individual’s consumption in both poorer and wealthier students is displayed in the below two graphs: