ded because a problem occurred. B3. Consumer Choice Theory A. Your friend has never studied economics. They hear something about income and substitution effects, and about how they can be used to distinguish between normal goods and inferior goods. Explain to your friend what a substitution effect is and what an income effect is and explain how they are used to distinguish between normal goods and inferior goods. B. Suppose that the price of petrol is originally €2 a litre. John has a monthly income of €200 and spends it all on petrol and other goods. In equilibrium he buys 20 litres of petrol a month. Draw a diagram illustrating this equilibrium position. Put litres of petrol on the horizontal axis and expenditure on all other goods on the vertical one. C. Suppose the price of petrol increases to €4 a litre. Draw his new budget line. Suppose that the government gave John a subsidy of €40 after the price of petrol increased. Illustrate the effect of this subsidy on your diagram. D. After the subsidy, is John as well off as he was before the price increase or is he better off? Explain your answer clearly. MacBook Pro

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