Answer to Question #98244 in Microeconomics for Emmanuel T. Chris

Question

4. For a two-good consumption basket, illustrate graphically the substitute and income effects when the price of one good (on x axis) decreases.
a. if the good is inferior good
b. if the good is giffen good

Answer 1

The consumer demand curve’s slope from left to right and slope depends on the price effect. The price effect is in two separate parts. Income effect of the price change and substitute effect of price change.

Inferior good

There is an inverse relationship between consumer income and demand. When price decreases in the price of inferior goods, the consumption of inferior goods will increase. The consumer has less utility in consuming inferior goods.

When the price of interior goods decrease, consumption of inferior goods decreases from $X2\to X3.$

$B$ rotates to $PL_1$ . consumption shifts from A to B because of the substitution effect. Because of the income effect consumption shits from $B\to C$ .

Giffen goods

Price of the Geffen goods and demand has a relative relationship. When price increases demand increases when the price falls demand falls. Every Giffen good is an inferior good, but every inferior good is not a Giffen good.

$BC$ rotates to$PL_1$

When $A\to B$ , consumption of Giffen good increase. It is the substitute effect of income.

When $B\to A$ , The consumption of Giffen decreases. It is the income effect.

Price of the Giffen goods decrease.