Answer to Question #59682 in Microeconomics for Zainab Aldahneem

Question

Use indifference and budget constraint diagram (one diagram for each case) illustrate and explain (suppose the two goods are neither perfect substitutes nor perfect complements):
(1) A consumer spends all his income on bread and juice. As the price of bread decreases, he now buys more of both bread and juice.
(2) A consumer spends all his income on honey and electronic games. As his income increases, he now buys more electronic games and less honey.
(3) A consumer spends all his income on books and drinks. As the prices of both books and drinks double, he now buys less of both goods.
(4) A consumer spends all his income on books and drinks. As his income is cut in half (50% of original level), he now buys less of both goods.

Answer 1

Task: Use indifference and budget constraint diagram (one diagram for each case) illustrate and explain (suppose the two goods are neither perfect substitutes nor perfect complements):
(1) As the price of bread decreases, his budget line shift to the right from B1 to B2 and intersects with the indifference curve U2 of higher level, at which consumer now can buy more bread and juice, in this case income effect for both goods is higher than substitution effect, because both bread and juice are normal goods, so with the increase in income its consumption increase too in almost the same proportion as before the change in price.
(2) As income increases, the budget line shifts parallel to the right from B1 to B2 and intersects with the indifference curve U2 of higher level. Honey is inferior good for consumer, so its consumption decreases, but electronic game is a normal good for consumer, so its consumption increases. In this case substitution effect for honey is higher than income effect.
(3) As the prices of both books and drinks double, then according to the income effect the budget line shifts parallel to the left from B1 to B2 and intersects with the indifference curve U2 of lower level, the consumption of both goods decreases in the same proportion, as both goods are normal. In this case substitution effect is lower than income effect.
(4) As his income is cut in half, then according to the income effect the budget line shifts parallel to the left from B1 to B2 and intersects with the indifference curve U2 of lower level (the situation is the same as in the previous question 3, but the shift is caused by the change in income which has the same result as in case of increase in price for both goods), the consumption of both goods decreases in the same proportion, as both goods are normal. In this case substitution effect is lower than income effect.