Answer to Question #291229 in Microeconomics for Loop

Question

Using indifference curves show the price effect, the substitution effect and income effect for the rise in the price of inferior good.

Answer 1

Using a parallel budget line of B-3,the substitution effect causes a big fall from a to b.

On the contrary, the income effect leads to an increase in demand (Q1 to Q2)

The overall demand decreases, but the substitution effect is partly offset by the income effect.This is because when income falls, the decrease in income leads us to buy more inferior goods because we can’t afford normal / luxury goods anymore.