Assume the budget line pivots outwards from b 2 to b

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Assume the budget line pivots outwards from B2to B1. The optimum consumption point willmove from point cto a.107As quantity demanded increases from Q1to Q2in Figure 4.15 the expenditure on all other goodsdecreases. (Pointbis lower than point a.) This means, therefore, that the person’s total expenditureon X has correspondingly increased. What, then, can we say about the person’s price elasticity ofdemand for X between points aand b? What can we say about the price elasticity of demandbetween points band cand points c andd?
60Chapter 4Between aand bthe demand for X is price elastic: a fall in the price of X leads to an increase inexpenditure on it. Between band cprice elasticity is equal to (minus) one: a fall in the price of Xleads to no change in expenditure. Between cand ddemand for X is price inelastic: a fall in priceleads to a reduction in expenditure on X (and hence an increase in expenditure on the total of allother goods).Illustrate on two separate indifference diagrams the income and substitution effects of the following(a)A decrease in the price of good X (and no change in the price of good Y).(b)An increase in the price of good Y (and no change in the price of good X)See Diagram 4.3 on the next page. In each case the substitution effect is shown by a movementfrom point ato point band the substitution effect is shown by a movement from point bto point c.109(Box 4.6) 1. If Judy earned more than Warren, show how much income she would redistribute to himif (a) she cared somewhat for him; (b) she loved him ‘as herself’. Draw her indifference curve in eachof these two cases.Assuming that their joint income remained the same as before (i.e. that Judy earned more butWarren earned less), then, if each spent their own income entirely on themselves, they wouldconsume at a point high up along the line YTYT: e.g. at a point between fand eJ.(a)If she cared somewhat for Warren, her optimum point would be somewhere like eJ. Herindifference map would be north-west of Warren’s, with the tangency point to her highestpossible indifference curve at eJ.(b)If she loved him ‘as herself’, the optimum point would be at eE.
61Chapter 4Page109(Box 4.6) 2. In the case where they both love each other ‘as themselves’, will their two sets ofindifference curves be identical?It depends on what precisely is meant by ‘loving each other as themselves’. Even if the optimumpoint for both Warren and Judy were at eE, the slope of their indifference curves may be verydifferent at points other than along the line of equality OE. In other words they may gain a differentindividual utility from an unequaldistribution of income.110(Box 4.7) 1. Make a list of the characteristics of shoes. Which are ‘objective’ and which are‘subjective’?Objective: size, durability, colour, material. Subjective: brand image, the appearance (pleasurable orunpleasurable), comfort.(Box 4.7) 2. If two houses had identical characteristics, except that one was near a noisy airport andthe other in a quiet location, and if the market price of the first house was £80000 and the secondwas £100000, how would that help us to put a value on the characteristic of peace and quiet?

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