Question

A consumer only consumes two commodities, x1 and x2. If x2 is an inferior good, and if p1 goes up, do the resulting Income and Substitution Effect on good 2 work in the same direction as each other, or in opposite directions of each other?

Answer 1

Answer:

A consumer only consumers two commodities, x1 and x2 .

2- now as the good being the inferior good the the price rise of the good will lead to negative substitution effect because if we keep income constant the high prices of the goods will change the consumer preference towards consuming good 2, now as income has fall due to lower pruchasing power now, thus the good being the inferior good the demand for the good will rise thus positive income effect thus both the effects works in opposite direction but in inferior goods the substitution effect dominates the income effect thus price effect overall is negative.