Figure: Income and Substitution Effects (Figure: Income and Substitution Effects) Look at the figure Income and Substitution Effects.Carlos is originally consuming his optimal consumption bundle at point A in the figure when the price of gasoline falls.The dashed line tangent to I1 shows a hypothetical budget line reflecting:

Question

Figure: Income and Substitution Effects   (Figure: Income and Substitution Effects) Look at the figure Income and Substitution Effects.Carlos is originally consuming his optimal consumption bundle at point A in the figure when the price of gasoline falls.The dashed line tangent to I1 shows a hypothetical budget line reflecting:

Quizplus · Accepted Answer

The dashed line tangent to I1 shows a hypothetical budget line reflecting the new relative prices of gasoline in terms of cell phone minutes and a change in income to keep Carlos on the original indifference curve. This reflects the substitution effect of the price change, as Carlos switches from the relatively more expensive cell phone minutes to the now relatively cheaper gasoline. The income effect, which indicates the change in consumption due to the change in purchasing power resulting from the change in price, is reflected in the movement to point B on the new budget line.