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Questions › UoH › UoH 2019 › Q80
1 mark, −0.33Microeconomics › Demand theory and elasticity › Income and substitution effects: the Slutsky equationModerateabout 1 min

UoH 2019 Question 80: Demand theory and elasticity

Answer following three questions (80 and 82) from information given in Diagram 1

Diagram 1: The initial equilibrium of the consumer is at point A where indifference curve I1 is tangent to the budget line BC1. If the price of commodity Y falls, the budget line shifts to BC2 and new equilibrium of the consumer is at point C.

In Diagram 1, the movement of the consumer from point A to point C is due to

Indifference curve diagram with Good Y on the horizontal axis and Good X on the vertical axis. Budget line BC1 is tangent to indifference curve I1 at A (X1, Y1); after the price of Y falls, the flatter budget line BC2 (same X intercept) is tangent to the higher curve I2 at C (X2, Y2); a dashed compensated line SC parallel to BC2 is tangent to I1 at B (Xs, Ys), with X2 > X1 > Xs and Y1 < Y2 < Ys on the axes.
Indifference curve diagram with Good Y on the horizontal axis and Good X on the vertical axis. Budget line BC1 is tangent to indifference curve I1 at A (X1, Y1); after the price of Y falls, the flatter budget line BC2 (same X intercept) is tangent to the higher curve I2 at C (X2, Y2); a dashed compensated line SC parallel to BC2 is tangent to I1 at B (Xs, Ys), with X2 > X1 > Xs and Y1 < Y2 < Ys on the axes.

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Demand theory and elasticity has come up 161 times in 7 exams since 2004.

What this question tests

This question is on Income and substitution effects: the Slutsky equation, part of Demand theory and elasticity in Microeconomics.

Splitting a price change into a substitution effect and an income effect, and why Giffen goods break the law of demand.

TestStop has 29 past-paper questions on this subtopic.

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