Dominick Salvatore Schaums Outline of Microeconomics, 4th edition Schaums Outline Series 2006

CHAP. 4] CONSUMER DEMAND THEORY 95
4.35 Starting from position A of consumer equilibrium in Fig. 4-31, determine (a) the total effect of the
reduction in P x from P 2 to P 1 ,(b) the substitution effect, and (c) the income effect. (d ) What type of
good is commodity X?
Fig. 4-31
(a) In Fig. 4-31, the consumer is originally in equilibrium at point A, budget line 1, and indifference curve
I. When the price of X falls from P 2 to P 1 (ceteris paribus), the consumer will reach equilibrium at point
C on budget line 2 and indifference curve II. The movement from A to C (or from Q 1 to Q 2 ) is the total
effect of the price change.
(b) To find the substitution effect of the price reduction, we must eliminate the income effect from the total
effect. This is accomplished by shifting down budget line 2 to budget line 2 0 . Budget line 2 0 is tangent to
indifference curve I at point B. The movement along indifference curve I from A to B (which equals Q 1
Q 3 ) is the substitution effect of the price change.
(c) Since the substitution effect (Q 1 Q 3 ) exceeds the total effect (Q 1 Q 2 ), the income effect must be opposite
the substitution effect. The income effect is given by a movement from B to C and equals Q 3 Q 2 .
(d) In this case, the income effect moves in the opposite direction from the substitution effect. Therefore,
commodity X is an inferior good. However, commodity X is not a Giffen good because when the
price of X falls, the quantity of X demanded per time period increases from Q 1 to Q 2 (the total
effect). Note that in this case, the demand curve along which real income is constant would be more
price-elastic than the demand curve along which money income is constant. However, both demand
curves are negatively sloped.
4.36 Starting from a position of consumer equilibrium, (a) show the substitution effect and the income effect
of a price reduction for a Giffen good. (b) Is the demand curve for a Giffen good along which real
income is held constant positively sloped? Why?
Fig. 4-32