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Questions › UoH › UoH 2019 › Q82
1 mark, −0.33Microeconomics › Demand theory and elasticity › Income and substitution effects: the Slutsky equationHardabout 2 min

UoH 2019 Question 82: Demand theory and elasticity

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

[Diagram 1: A consumer's indifference-curve diagram with Good X on the vertical axis and Good Y on the horizontal axis. Initial equilibrium is at point A where indifference curve I1 is tangent to budget line BC1. The price of commodity Y falls, so the budget line pivots out to BC2 and the new equilibrium is at point C on the higher indifference curve I2. A dashed compensated budget line parallel to BC2 is tangent to I1 at point B. Quantities of Good Y are marked Y1 at A, Y2 at C and Ys at B; quantities of Good X are marked X1 at A, X2 at C and Xs at B.]

In Diagram 1, good Y is an inferior good because

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.

Practise Demand theory and elasticityMore on Income and substitution effects: the Slutsky equation

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