Substitution and Income Effects

timer Asked: Feb 25th, 2016

Question description

Using the consumer choice model, start from aconsumer optimum position.  Label the graph with hamburger on the x-axis and jeans on they-axis.  Show what happens when the price of hamburger is reduced.
a) (3 pts) In the first graph, assume that hamburger is a normal good relative to jeans.Indicate the new optimum and show the substitution effect and the income effect of the
price reduction.

b) (3 pts) In the second graph assume the same price reduction, but now assume thathamburger is an inferior good.c) (2 pts) Observing the difference between the first graph and the second graph, what canyou conclude about the slope of the Price Consumption Curve between normal goods andinferior goods.d) (2 pts) Again observing the difference between the two results what can you concludeabout the elasticity of normal goods versus inferior goods.

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