Question

Suppose a typical U.S. consumer devotes his or her transportation budget to the purchase of gasoline (G) and gas-powered vehicles (V). a. Graph the indifference curves a typical consumer faces. Do not assume these goods are perfect complements. (2 points) b. Use your graph in part (a) to illustrate the effect of an increase the gas price, noting the income and substitution effects on gas and vehicles. (6 points) c. What is the algebraic expression for the cross price elasticity of demand for vehicles with respect to gas prices? What is the expected sign of this elasticity? (2 points)

Answer 1

la praw convex shaped indifference curvas - between V and G b) with a budget line the corrent choice of consumption bundle is A. when taxes are imposed on gas price it increases and so budget line tilts inwards. This causes both a substitution and income effect. Here the substitution effect. dominates the income effect. The former induces him to buy less G and more v while income effect induces him to buy fewer quantity of both the goods . A total Price effect influences him to have less G and more v IC -Tez G2 G GY

page No Date: / c) if demand equation is Q: a b px - cpy where x and y are Prices of two related goods, the cross Price elasticity of demand is given as cc slope of the demand function with respect to y X Py/ax ec = -c * Py/ax we expect gas Prices to be inversely related because if gas Prices are increased they will reduce the quantity demanded of gasonline and Simultaneously reduce the demand for vehicles.