Answer to Question #281368 in Microeconomics for vivian

Question

(Hicks decomposition) A consumer spends an income of m on two goods x1 and x2. The price of x1 is p1, and the price of x2 is p2. Draw pictures and use the Hicks decomposition to illustrate the income effect and substitution in the following two cases.

(i) Initially, the consumer spends all his money on x2. Show how an increase in p1 affects the consumer’s choice.

(ii) Initially, the consumer purchases both goods. Show how an increase in p1 affects the consumer’s choice of x2 if x2 is inferior goods.

Answer 1

(i) If the consumer spends all his money on x2, then in case of increase in p1 the consumer’s choice will be the same.

(ii) If the consumer purchases both goods, then an increase in p1 will increase consumption of x2 if x2 is inferior good.