Answer to Question #79812 in Microeconomics for Ahsan Siddiqui

Question

Assuming that x is a normal good and y is an inferior good, decompose the total effect (a) of a reduction in the price of a normal good (b) of an increase in the price of y into the income and substitution effect components? What will happen in each case if the income effect is too large?

Answer 1

In economics, an inferior good is a good whose demand decreases when consumer income rises (or demand rises when consumer income decreases).
a) As a consumer's income increases the demand of inferior good (Y) will decrease, while demand a normal good (X) will increase. Reduction in the price of a normal good (X) will tend to increase the quantity of this good (X), so the consumers will buy less an inferior good (Y), and the demand of inferior good (Y) will decrease.
b) When price of an inferior good (Y) raises, its negative income effect will tend to increase the quantity purchased a normal good (X), while the substitution effect will tend to reduce the quantity purchased of an inferior good (Y).
If income effect is too large, then
a) the quantity demanded of an inferior good (Y) will reduce and of a normal good (X) will increase
b) the quantity demanded of an inferior good (Y) will increase and of a normal good (X) will reduce.