ch4_example2

ch4_example2 - b. Determine if product B is a normal,...

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The following data pertain to products A and B, both of which are purchased by Madame X. Initially, the prices of the products and quantities consumed are: , $10 P A = , 3 Q A = , $10 P B = 7. Q B = Madame X has $100 to spend per time period. After a reduction in price of B, the prices and quantities consumed are: , $10 P A = , 2.5 Q A = , $5 P B = . 15 Q B = Assume that Madame X maximizes utility under both price conditions above. Also, note that if after the price reduction enough income were taken away from Madame X to put her back on the original indifference curve, she would consume this combination of A and B: , 1.5 Q A = . 9 Q B = a. Determine the change in consumption rate of good B due to (1) the substitution effect and (2) the income effect.
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Unformatted text preview: b. Determine if product B is a normal, inferior, or Giffen good. Explain. Solution: a. The total effect of the price change is the difference in the quantities before and after the price change, or 15 - 7 = 8. This change of 8 includes the income and substitution effects. The reduction in consumption that resulted from the reduction in income to put Madame X back on the original indifference curve represents the income effect. This difference is 15 - 9 = 6. The difference between 15 - 7 = 8 and 15 - 9 = 6 is the substitution effect, i.e. 8 - 6 = 2. b. Since the two effects are additive and both are positive, we have a normal good, i.e., 6 + 2 = 8....
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ch4_example2 - b. Determine if product B is a normal,...

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