Reference no: EM132196954

Question: On the following page you will find indifference curves representing a person's preferences between two goods. You will derive the demand curve for good-x for this person and identify the substitution and income effects. This person has a budget of $240. The initial price for good-x is $12 and the initial price of good-y is $12.

a) On the graph, draw the initial budget constraint and label it BCA. Next, label the point at which this person will consume as A.

b) Now let the price of good-x increase to $20. Draw the new budget constraint and label it as BCB. Label the point which this person will consume at the new prices as B.

c) Use the information from the two optimal points you found to draw a linear demand curve on the lower set of axes. Label this demand curve as D.

d) Now identify the size of the substitution and income effects for this change. Draw the compensated budget constraint and label it as BCC. Label the compensated consumption point as C. On the graph identify the income and substitution effects.

e) Finally, based on your analysis of this person's preferences, is good-x a normal or inferior good? Again, based on your analysis of this person's preferences, are good-x and good-y substitutes or complements?