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Chap005EndofChapterproblems - CHAPTER 5 INTRODUCTION TO...

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CHAPTER 5 INTRODUCTION TO NEOCLASSICAL TRADE THEORY: Answers to End-of-Chapter Questions and Problems 1. In the graph below, the initial equilibrium is at point E 1 with relative prices (P X /P Y ) 1 . If the price of good X falls while the price of good Y remains constant, then a new flatter price line (P X /P Y ) 2 line emerges from the original intercept at point A on the vertical axis. Because MU X /P X is now greater than MU Y /P Y at E 1 , the consumer will substitute toward greater consumption of the X good and less consumption of the Y good in order to increase total satisfaction. Equilibrium will move from E 1 to E 2 , and the consumer will be on a higher indifference curve and will have increased the relative consumption of good X. Only if good X is a sufficiently “inferior” good will the relative increase in the quantity of X consumed not occur. 2. Consider an indifference curve diagram such as Figure 3 in the text. A shift in the income distribution toward consumers with a relatively stronger preference for good Y than in the original distribution (the distribution with the solid lines) will make each curve “flatter” and will shift each curve leftward toward the vertical axis. The curves become flatter because, for any total amount of Y taken away from consumers at the margin in proportion to their incomes, more X must be given to the community as a whole in order to restore each consumer to his or her original level of satisfaction. The leftward shift occurs because, at each given total amount of good Y consumed (which is now more preferred), less X is necessary in order for the community as a whole to attain a given utility level.
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