# Ii the income effect of the price change on bananas

This preview shows pages 3–5. Sign up to view the full content.

ii) the income effect of the price change on bananas. Ans: the increase in the price of bananas, with a fixed income and a constant price of scones, means that if Rajan chooses to purchase any bananas his real income is now lower than it was before the price increase - his budget set has shrunk. This is similar to a change in money income: the original optimal bundle is no longer attainable, and he must move to a new, lower, IC. The income effect of the price change on bananas reflects the change in quantity of bananas purchased as a result of the movement from the original to the new indifference curve. f) (4) Identify the effects in (e) on your diagram. Ans: substitution effect measured along original IC, from MRS = 6/5 to MRS= 12/5; income effect measured from original to new, lower, IC, with MRS=12/5.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Name___________________________________________________________ Student number _________________________________ Lab LF0__________ Economics 203 (F01), 2005; midterm 1 Page 4 of 5 g) (5) If Rajan's income increased so he could just purchase his initial optimal bundle at the new prices, would he choose to do so? Explain why or why not (with reference to the diagram if you wish). Ans: No, he would not choose his initial bundle. The change in relative prices causes him to adjust his consumption to restore MRS = price ratio. Even if the original bundle is now just affordable, Rajan could attain a higher utility by purchasing fewer bananas, and more scones, than he originally did.
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern