Refer to Exhibit 4. Suppose that the consumer must choose between buying socks and belts. Also, suppose that the consumer's income is €100. Suppose that the price of a pair of socks has falls from €5 to €2. The income effect is represented by the movement from point?
A) Y to point X.
B) X to point Z.
C) X to point Y.
D) Z to point X.

Question

Refer to Exhibit 4. Suppose that the consumer must choose between buying socks and belts. Also, suppose that the consumer's income is €100. Suppose that the price of a pair of socks has falls from €5 to €2. The income effect is represented by the movement from point? ​  ​
A) Y to point X. 
B) X to point Z. 
C) X to point Y. 
D) Z to point X.

Quizplus · Accepted Answer

The income effect is represented by the movement from point X to point Y. At the original prices, the consumer could afford to purchase 20 units of socks or 10 units of belts or any combination of both on the budget constraint line. After the price of a pair of socks falls from €5 to €2, the consumer's purchasing power increases, allowing him/her to buy more socks and/or belts. As a result, the budget constraint line shifts to the right, from BC1 to BC2, and the optimal consumption point moves along the new budget constraint line from point X to point Y. At point Y, the consumer can buy 40 units of socks and 10 units of belts, which is a better choice than point X where the consumer could only buy 20 units of socks and 10 units of belts at the original prices.