ECON 103 Show the effect of a rise in income on the demand for X and Y ( LATEST UPDATE )

ECON 103 Show the effect of a rise in income on the demand for X and Y. Show the effect of a rise in income on the demand for X and Y where this time Y is the inferior good and X is the normal good. Is the income–consumption curve positively or negatively sloped? Answer The curve will slope upwards at first, but become less and less steep. It will then peak at the point where Y becomes an inferior good, and will thereafter slope downwards (i.e. have a negative slope). Illustrate on an indifference diagram the effects of the following: Answer (a) A rise in the price of good X (assuming no change in the price of Y). (b) A fall in the price of good Y (assuming no change in the price of X). (a) The budget line will pivot inwards (e.g. from B2 to B1 in Figure 4.14, causing a fall in consumption from point k to point j). (b) The budget line would pivot outward on the point where the budget line crosses the horizontal axis. It is likely that the new tangency point with an indifference curve will represent an increase in the consumption of both goods. Diagram 4.3 below can be used to illustrate this. Assume the budget line pivots outwards from B2 to B1. The optimum consumption point will move from point c to a. decreases. (Point b is lower than point a.) This means, therefore, that the person’s total expenditure on X has correspondingly increased. What, then, can we say about the person’s price elasticity of demand for X between points a and b? What can we say about the price elasticity of demand between points b and c and points c and d? Answer Between a and b the demand for X is price elastic: a fall in the price of X leads to an increase in expenditure on it. Between b and c price elasticity is equal to (minus) one: a fall in the price of X leads to no change in expenditure. Between c and d demand for X is price inelastic: a fall in price leads to a reduction in expenditure on X (and hence an increase in expenditure on the total of all other goods). . If Judy earned more than Warren, show how much income she would redistribute to him if (a) she cared somewhat for him; (b) she loved him ‘as herself’. Draw her indifference curve in each of these two cases. Answer Assuming that their joint income remained the same as before (i.e. that Judy earned more but Warren earned less), then, if each spent their own income entirely on themselves, they would consume at a point high up along the line YTYT: e.g. at a point between f and eJ. (a) If she cared somewhat for Warren, her optimum point would be somewhere like eJ. Her indifference map would be north-west of Warren’s, with the tangency point to her highest possible indifference curve at eJ. (b) If she loved him ‘as herself’, the optimum point would be at eE.