1. Income and substitution effectsMusashi and Rina Xiang live in Dallas and enjoy going out to fancy restaurants for dinner and to coffee shops for breakfast. On the following graph,the purple curves U₁ and U₂ represent two of their indifference curves for dinners and breakfasts. They have $800 per month available to spend oneating out. The price of a breakfast is always $10. Each labeled point represents the tangency between a budget constraint and the correspondingindifference curve.BREAKFASTS260betterIworse02BC,15I10DINNERSHFancy DinnersSubstitution EffectIncome Effect-U₂U₁The initial budget constraint (BC₁) shows the Xiangs' budget constraint when the price of a fancy dinner is $160. At this price, Musashi and Rinawould choose to consume two dinners.BCSuppose that the price of a fancy dinner decreases to $40, shifting their budget constraint to BC2, which represents a new relative price of fourbreakfasts per dinner. (Hint: The blue line labeled H is parallel to BC₂ and tangent to U₁ at point Y.)In order to remain as happy as they were before the price decrease-that is, to consume at some point on the same indifference curve as they wereon initially (U₁)-the Xiangs' income spent on dinners and breakfast would now only have to be S ]. However, in reality, rather thanmaintaining their original level of utility, the Xiangs choose the optimal bundle along their new budget constraint. At this point, they areoff than before the price change in dinners.(?)Complete the following table by indicating which point movement represents the substitution effect and income effect for dinners when the pricedecreases from $160 to $40. Then indicate whether each effect is positive or negative in this case.Consumption ChangeRepresented By... (Quantity of dinners)Positive or NegativeIn this case, the price decrease of dinners causes the Xiangs' real income toand the direction of the income effect, dinners arefor the Xiangs.Because of the change to Musashi and Rina's real income

A compensating variation is the amount of extra money that a consumer will need to reach to their…

better worse Complete the following table by indicating which point movement represents the substitution effect and income effect for dinners when the price decreases from $160 to $40. Then indicate whether each effect is positive or negative in this case. Fancy Dinners Substitution Effect Income Effect Consumption Change Represented by... (Quantity of dinners) Positive or Negative In this case, the price decrease of dinners causes the Xiangs' real income to and the direction of the income effect, dinners are for the Xiangs. Because of the change to Musashi and Rina's real income

better worse Complete the following table by indicating which point movement represents the substitution effect and income effect for dinners when the price decreases from $160 to $40. Then indicate whether each effect is positive or negative in this case. Fancy Dinners Substitution Effect Income Effect Consumption Change Represented by... (Quantity of dinners) Positive or Negative In this case, the price decrease of dinners causes the Xiangs' real income to and the direction of the income effect, dinners are for the Xiangs. Because of the change to Musashi and Rina's real income

ENGR.ECONOMIC ANALYSIS

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ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

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Question

1. Income and substitution effects
Musashi and Rina Xiang live in Dallas and enjoy going out to fancy restaurants for dinner and to coffee shops for breakfast. On the following graph,
the purple curves U₁ and U₂ represent two of their indifference curves for dinners and breakfasts. They have $800 per month available to spend on
eating out. The price of a breakfast is always $10. Each labeled point represents the tangency between a budget constraint and the corresponding
indifference curve.
BREAKFASTS
26
0
better
I
worse
02
BC,
1
5
I
10
DINNERS
H
Fancy Dinners
Substitution Effect
Income Effect
-U₂
U₁
The initial budget constraint (BC₁) shows the Xiangs' budget constraint when the price of a fancy dinner is $160. At this price, Musashi and Rina
would choose to consume two dinners.
BC
Suppose that the price of a fancy dinner decreases to $40, shifting their budget constraint to BC2, which represents a new relative price of four
breakfasts per dinner. (Hint: The blue line labeled H is parallel to BC₂ and tangent to U₁ at point Y.)
In order to remain as happy as they were before the price decrease-that is, to consume at some point on the same indifference curve as they were
on initially (U₁)-the Xiangs' income spent on dinners and breakfast would now only have to be S ]. However, in reality, rather than
maintaining their original level of utility, the Xiangs choose the optimal bundle along their new budget constraint. At this point, they are
off than before the price change in dinners.
(?)
Complete the following table by indicating which point movement represents the substitution effect and income effect for dinners when the price
decreases from $160 to $40. Then indicate whether each effect is positive or negative in this case.
Consumption Change
Represented By... (Quantity of dinners)
Positive or Negative
In this case, the price decrease of dinners causes the Xiangs' real income to
and the direction of the income effect, dinners are
for the Xiangs.
Because of the change to Musashi and Rina's real income

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