Econ Micro (book Only)
6th Edition
ISBN: 9781337408066
Author: William A. McEachern
Publisher: Cengage Learning
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Question
Chapter 12, Problem 2P
To determine
Enlighten whether the effects are income or substitution when the cost of living increases and when there is a reduction in the
Concept Introduction:
Income effect:
This is described as the change in the quantity of goods and services due to a change in the income of the people.
Substitution effect:
This is an economic theory in which when the price rises or income of the people falls, people will substitute the dearer goods with less expensive alternative goods.
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05- Income and Substitution Effects
Question 8
(Substitution and Income Effects) Suppose that the cost of living increases, thereby reducing the purchasing power of your income. If your money wage doesn’t increase, you may work more hours because of this cost-of-living increase. Is this response predominantly an income effect or a substitution effect? Explain.
Kamika lives in Chicago but goes to school in Tucson, Arizona. For the last 2 years, she has made four trips home each year. During 2010, the price of a round-trip ticket from Chicago to Tucson increased from 350 to 600. As a result, Kamika decided not to buy a new outfit that year and decided not to drive to Phoenix with friends for an expensive rock concert.
QUESTION:
By using this example, explain why both income and substitution effects might be expected to reduce Kamika’s number of trips home
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- A family of four has an income of $15,000 today and will earn $24,000 tomorrow. i). If the family consumes $11,500 in the first period and $15,000 in the second period, whatis the interest rate? ii). If the family consumes $15,000 in the first period and $13,500 in the second period, whatis the interest rate? iii). Explain the income and substitution effects and discuss which effect dominated after theinterest rate change from part (a.) to part (b.).arrow_forwardQ42 Suppose the price of potatoes falls and we observe a decrease in an individual's purchases of potatoes. Which of the following can we infer? a. The substitution effect outweighs the income effect. b. The income effect just offsets the substitution effect. c. The income effect is negative and reinforces the substitution effect. d. The income effect is positive and exceeds the substitution effect. e. The income effect is negative and outweighs the substitution effect.arrow_forwardJeff spends all of his money on housing (H) and other stuff (S) and has a diminishing marginal rate of substitution between housing and stuff. Jeff used to live and work in a small town where housing prices were relatively low. His company has decided to transfer him to a large city where housing prices are higher. (For simplicity, assume that all other prices are the same.) Using a diagram, explain to Jeff's company how to find the amount it needs to raise his salary to keep him just as well after the 2. transfer as he was before. Tridorarrow_forward
- Question 12 As we move along an indifference curve, the marginal rate of substitution decreases. This is in essence due to: limitations in the increase of production The law of diminishing marginal utility. There is actually no reason for this. limits in incomearrow_forwardDefine The income and substitution effects.arrow_forwardQUESTION 24 Given a certain a budget line, an increase in money income will: have no effect on the budget line. shift the budget line to the right. shift the budget line to the left. shift the budget line outward on the horizontal axis, but leave it anchored at "10" on the vertical axis. QUESTION 25 A change in the slope of a budget line is solely the result of a change in: money income. the marginal rate of substitution. the price of one or both goods. consumer preferences.arrow_forward
- Subject: Business economics Q1) A consumer spends all her income on food and clothing. At the current prices of price of food = Rs. 10 and price of cloth = Rs. 5, she maximizes her utility by purchasing 20 units of food and 50 units of clothing.(Hint: Take food on x-axis and cloth on y-axis) What is the consumer’s income? What is the consumer ‘s marginal rate of substitution of food for clothing at the equilibriumarrow_forward12. [G] To find the Income/Substitution effects, graphically we find the point on the original indifference curve that is tangent to a line having the slope of the new budget line. We call this point (xub, x2ubs) Analytically, we can find this point as well. Specifically, the solution to what two equations will give us (x1ubs x2subs) ? Hint: It's the two equations that are equivalent to the graphical approach of finding this point. U, (xubs xubs) Pew U2 (xub xubsy ppew ubs xubs) Uz(xubs xubsy U, (xubs xgubsy A. 1-Pnewxubs - Pnewx2" subs 03; В. U(x1oris,x2ori) = U(x1ubs xubs); Pnew Pnew С. I- P,origxsubs– P,origx,subs= 0: Phew Uz (x{ubs xubs) Pnew D. U(x1"e",x2 mew) = U(x1ubs x ubs). U;(x}ubs x3ubs)_ Pporig Uz (xubs xubs) Porig E. None of the above system of equations will correctly solve for (x1ubsarrow_forward
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