Chapter%204%20Practice%20B%20-%20Answers

Chapter%204%20Practice%20B%20-%20Answers - Chapter 4...

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Chapter 4 Practice B - Answers 1. Consider the following: a. Can a good have both a downward-sloping Engel curve and a downward-sloping demand curve? Why or why not? Yes, they can both be downward sloping. This occurs when the good is inferior (according to Engel curve) but not Giffen (according to demand curve). b. Can a good have both an upward-sloping Engel curve and an upward-sloping demand curve? Why or why not? No, they can’t both be upward sloping. If the Engel curve is upward sloping, then the good must be normal. However, the Law of Demand always holds for normal goods, because the income effect reinforces the substitution effect for normal goods. Thus, an upward-sloping Engel curve guarantees the demand curve is downward sloping. 2. Suppose the demand curve for bus travel is downward sloping, and the income elasticity of demand for bus travel is negative. a. Design an indifference curve / budget constraint diagram showing the substitution and income effects created when the price of bus travel falls. In your diagram, place bus travel on the horizontal axis and all other goods on the vertical axis. Bus travel is an inferior good because the income elasticity of demand is negative, so the substitution and income effects must be in opposite directions. Since the demand curve for bus travel is downward sloping, the substitution effect must be larger than the income effect. This situation is shown in the graph below, where point A is the initial optimum and point B is the final optimum.
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b. How can you tell from your diagram that the income elasticity of demand for bus travel is negative? Explain. Consider points B and C in the graph above.
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Chapter%204%20Practice%20B%20-%20Answers - Chapter 4...

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