Question

Answer A. and B. below by looking at the relevant income and substitution effects. Draw graphs to support your answers. A. If the quantity demanded of a good increases when its price alone falls, then the demand for that good must also Increase when income alone rises. Do you agree or disagree? Explain. (4 points)

Answer 1

According to the Law of demand, under ceteris paubu - condition, if an price of a commodity falls, the dement for it rises and when peace of the commodity rises the demand for it falls. So I there is an inverse rucahon shif belumen quantity demanded of a commodity and its price a The con be shown with the helf of following bolloomine diagram. O Pooral ام و لی . اشه Quantity o. Q. Qi

ncome So the demand cwere is dawn ward sloping But the question is when the dd cune deaunward sloping ? ( This is because of ?- Substitution effect Income affect Lets discuss income effect first. Suppose the the price of a good golls , say from Pare P. (P. CP2), the consumer will have greater purchasing power (even if his income does not change ). This induces him to increas hes demand for the commodity from Q2 le a, (Q.)Q2). This is income affect. The's happens in the case of normal goods. (exception: infricon) good)

Substitution effect: - when the relatine price of a commo lite Halls, this commodiy becomes more attractive to the consumer thom other commodities. Hence the consumer will substitute this Commodity for others. Hence when the bric of the commodity falls from 2 to P the quenting demanded of the commoditi rises from Qato Qs.