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Economics:2000 paper Question 1 (B)

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  • 14-06-2008 3:43pm
    #1
    Soby
    Registered Users Posts: 5,977 ✭✭✭


    "A consumer spends all income on two goods,Good X and Good Y.Both goods are normal goods but they are not complementary goods. The Price of good X is reduced and the price of Good Y remains unchanged.. The consumer continues to spend all income on the two goods.
    Explain using the Substitution effect and income effect how this price reduction affects the demand for both goods"..

    Right...This came up in 2003 Question 3 but that Q only asked for Good A(which is good X in this case)..So i have the sub+income effect for Good X..i just need to know what it is for Good Y...
    Ive guessed that the sub effect for Y i just said stays same and the income effect i said with the extra income available it goes towards good A due to the fall in price(Fall in price doesnt mean its the cheaper of the two though)....This is more than likely wrong though...Any ideas???

    And BTW the examinations.ie marking schemes only go back to 2001 so this is why im stuck..and the book doesnt exactly help either


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    #2
    Peleus
    Registered Users Posts: 784 ✭✭✭Peleus


    Sub effect
    Under the substitution effect good X becomes relatively cheaper than good Y. The substitution effect is always in favour of the relatively cheaper good. Therefore as the price of Good X falls, it becomes relatively cheaper than Good Y and more of it is demanded. Under the substitution effect the demand for Good X will rise and the demand for good Y will fall.

    Inc effect
    As the price of Good X falls, the consumer has more disposable income as less is being spent on these goods. Both Good X and Good Y are normal goods (goods with a positive income effect). The income effect is always in favour of normal goods. Therefore as the prics of Good X falls, the consumer has more disposible income and more will be demanded of Good X and Good Y.



    _________Sub effect_____ Inc effect______Total effect
    Good X_____D (up)_________ D(up)________ D(up)
    Good Y ___D (down) ________D(up)_________D(up/down)

    Total effect for good X is an increase in Demand
    Total effect for good Y is either and increase or a decrease in demand depending on which effect is stronger


    Hope that helps!!!


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