Answer to Question #307968 in Microeconomics for lydia

Question

Diana consumes potatoes and other goods (potatoes is an inferior good). Using an indifference curve analysis show the effects that determine Diana s final consumption of these two goods. (Hint price for potatoes increase).

Answer 1

Inferior goods which in this case is potatoes, the substituion effect is seen to work in opposite direction to the income effect. A rise in price of potatoes rises, its negative substituion effect which will tend to reduce the quantity purchased, while the income effect will tend to increase the quantity purchased.

In normal cases it happens that negative substituion effect of change in price is not large enough to outweigh the income effect.

The reason behind this is that a consumer spends a very small proportion of his income on a single commodity and if the price of a commodity rises, then a very little income is released. In other words substituion effect even when negative is generally too weak to outweigh the income effect.