Answer to Question #278153 in Microeconomics for Nish

Question

Construct graph and explain income and substitution effect of a price change for food

(on X-axis) and cloth (on Y-axis) when a) food is a normal good and b) food is an inferior

good. Suppose price of food is continuously decreasing, with no change in the price of cloth

and income, what curves can you derive from this change?

Answer 1

Assume the consumer is originally in equilibrium point R on the normal budget PQ, where the indifference curve I1, at point R in Figure 32, is tangent to it. Allow the price of good X to drop. As a consequence, his normal budget swings outward to PQ, with the buyer in equilibrium point T on the higher indifference I1. The market price of the reduction in the price of X is the shift from R to T or B to E on the horizontal axis. The income of the customer rises as the price of X falls.