Sean and Yvette Durand live in Edmonton and enjoy going out to fancy restaurants for dinner and to diners for breakfast. On the following diagram, the purple curves I₁ and 12 represent two of their indifference curves for fancy dinners and diner breakfasts. They have $800 per month available to spend on eating out. The price of a diner breakfast is always $10. Each labelled point represents the tangency between a budget constraint and the corresponding indifference curve. DINER BREAKFASTS 28 BC 025 10 FANCY DINNERS BC (?) The initial budget constraint (BC₁) shows the Durands' budget constraint when the price of a fancy dinner is $160. At this price, Sean and Yvette would choose to consume two fancy dinners. 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 diner breakfasts per fancy dinner. (Hint: The blue line labelled H is parallel to BC₂ and tangent to I₁ 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 (11)--the Durands' income spent on fancy dinners and breakfasts at diners would now only have to be $ . However, in reality, rather than maintaining their original level of utility, the Durands choose the optimal bundle along their new budget constraint. At this point, they are off than before the price change in fancy dinners. On the following table, indicate which point movement represents the substitution effect and income effect for fancy dinners when the price decreases from $160 to $40. Then indicate the consumption change that results from each effect. Fancy Dinners Substitution Effect Consumption Change Represented By... (Quantity of fancy dinners) Income Effect In this case, the price decrease of fancy dinners causes the Durands' real income to income and the direction of the income effect, fancy dinners are . Because of the change to Sean and Yvette's real for the Durands.
Sean and Yvette Durand live in Edmonton and enjoy going out to fancy restaurants for dinner and to diners for breakfast. On the following diagram, the purple curves I₁ and 12 represent two of their indifference curves for fancy dinners and diner breakfasts. They have $800 per month available to spend on eating out. The price of a diner breakfast is always $10. Each labelled point represents the tangency between a budget constraint and the corresponding indifference curve. DINER BREAKFASTS 28 BC 025 10 FANCY DINNERS BC (?) The initial budget constraint (BC₁) shows the Durands' budget constraint when the price of a fancy dinner is $160. At this price, Sean and Yvette would choose to consume two fancy dinners. 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 diner breakfasts per fancy dinner. (Hint: The blue line labelled H is parallel to BC₂ and tangent to I₁ 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 (11)--the Durands' income spent on fancy dinners and breakfasts at diners would now only have to be $ . However, in reality, rather than maintaining their original level of utility, the Durands choose the optimal bundle along their new budget constraint. At this point, they are off than before the price change in fancy dinners. On the following table, indicate which point movement represents the substitution effect and income effect for fancy dinners when the price decreases from $160 to $40. Then indicate the consumption change that results from each effect. Fancy Dinners Substitution Effect Consumption Change Represented By... (Quantity of fancy dinners) Income Effect In this case, the price decrease of fancy dinners causes the Durands' real income to income and the direction of the income effect, fancy dinners are . Because of the change to Sean and Yvette's real for the Durands.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:9. Income and substitution effects
Sean and Yvette Durand live in Edmonton and enjoy going out to fancy restaurants for dinner and to diners for breakfast. On the following diagram,
the purple curves I1 and 12 represent two of their indifference curves for fancy dinners and diner breakfasts. They have $800 per month available to
spend on eating out. The price of a diner breakfast is always $10. Each labelled point represents the tangency between a budget constraint and the
corresponding indifference curve.
DINER BREAKFASTS
48
40
26
BC
0 2
5
10
Z
H
BC
FANCY DINNERS
(?)
The initial budget constraint (BC₁) shows the Durands' budget constraint when the price of a fancy dinner is $160. At this price, Sean and Yvette
would choose to consume two fancy dinners.
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 diner
breakfasts per fancy dinner. (Hint: The blue line labelled H is parallel to BC2 and tangent to I₁ 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 (11)--the Durands' income spent on fancy dinners and breakfasts at diners would now only have to be $ . However, in reality,
rather than maintaining their original level of utility, the Durands choose the optimal bundle along their new budget constraint. At this point, they are
off than before the price change in fancy dinners.
On the following table, indicate which point movement represents the substitution effect and income effect for fancy dinners when the price decreases
from $160 to $40. Then indicate the consumption change that results from each effect.
Consumption Change
Fancy Dinners
Represented By... (Quantity of fancy dinners)
Substitution Effect
Income Effect
In this case, the price decrease of fancy dinners causes the Durands' real income to
income and the direction of the income effect, fancy dinners are
. Because of the change to Sean and Yvette's real
for the Durands.
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