2. Identifying normal, inferior, and Giffen goods Aa Aa Suppose that I1 on the f

Question

2. Identifying normal, inferior, and Giffen goods Aa Aa Suppose that I1 on the following graph represents your initial budget constraint for good X and good Y, and point A represents the optimal choice, given this choice set. After a change in the price of good Y, your new budget constraint is now 12. The budget that would allow for the initial level of consumption based on the new prices is parallel to 12, representing the same tradeoff between good X and good Y, and it is tangent to the given indifference curve (U) at point B. GOOD Y 12 Hypothetical Budget GOOD X If point C represents the new optimal choice, what kind of good is good Y? O Inferior good, but not a Giffen good Normal good O Giffen good QNA 3.16 2004-2016 Aplia. All rights reserved.

Explanation / Answer

Comparing A and C, we see that the price of Y has reduced because budget has expanded. Now at C, the quantity of Y is higher than its quantity at A. From A to B, there is a substitution effect and from B to C there is an income effect. SInce ME > SE, Y is a Giffen good

Hence Y is a Giffen good.

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