Consider the following graph: 1. x 1 A =80 represents the optimal choice of x 1

Question

Consider the following graph:

1. x1A=80 represents the optimal choice of x1 at the original prices and income and then P1 increases. Use this information to respond the following question.

What is the income effect from the change in P1? (hint: be mindful of the signs, the number can be positive or negative).

2. x1A=80 represents the optimal choice of x1 at the original prices and income and then P1 increases. Use this information to respond the following question.

What is the total change in x1 after the increase in P1? (hint: be mindful of the signs, the number can be positive or negative)..

3. x1A=80 represents the optimal choice of x1 at the original prices and income and then P1 increases. Use this information to respond the following question.
What is the substitution effect from the change in P1? (hint: be mindful of the signs, the number can be positive or negative).

Explanation / Answer

Using the Slutsky method of decomposition of price effect into income effect and substitution effect

1. Income effect = 3-35 = -32

2.Total change in x1 = 3-80 = -77

3. substitution effect = 35-80 = -45

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