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Report Thread starter 2 years ago
Hi, I need some help with this question. When the price of the normal good increases, I get that the purchasing power decreases. But I read somewhere that this leads to lower consumptions of both goods. A different source states that this leads to a lower consumption of food only. In my answer, I assumed that the increase in price of food leads to lower consumption of food but higher consumption of clothings. I don't know which explanation is right because surely if both consumptions decrease then the new point B will be below the original point A which doesn't sound right.

My second question is that I have predicted a wrong point for B since the answer states that B is between A' and A but how do you know this? And why is this the case? Does it matter ?

Many thanks
Badges: 14
Report 2 years ago
I understand that substitution effect will always be negative regardless of the type of good, so when price of food rises, quantity of food declines (moving from A to A’) first due to substitution effect.

For normal good, income effect will also be in the same direction as substitution effect so quantity of food declines further which doubles the negative effect from price increase (moving from A’ to B).

For inferior good, income effect will be positive (quantity will rise instead) but the increase will be less than substitution effect , so overall effect will still be negative but less than for normal good (B falls within A and A’)

For Giffen good, the income effect will be positive and larger than substitution effect, so the increase in quantity will outweigh the drop and overall effect will turn to be positive (B placed greater than A).

For the change consumption of clothing I think it is reflected in the substitution effect when clothing becomes relatively cheaper (from A to A’) and quantity of clothing rises.

For the subsequent one ,which is income effect for normal goods, it means purchasing power has decreased and quantity consumed of both have to decline but I think the net effect for clothing will depend on the preference reflected in the shape of indifference curve to tell that whether a rise from substitution effect or drop from income effect should be greater.

I’m not quite if if this is what you’re after but hope at least it can explain or clarify something ^_^

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