Refer to the graph below. Assume the consumer has an income of $100, the price of X is $2 and the price of Y is $1. According to the graph below, the total effect of a decrease in the price of X from $2 to $1 is equal to:

Question

Quizplus · Accepted Answer

According to the graph, the initial budget constraint is AB. When the price of X reduces to $1, the budget constraint shifts out to CD.

The substitution effect is the movement from point A to point B', where the consumer substitutes some of Y for X due to the relative price change. The income effect is the movement from point B' to point D, where the consumer can afford to buy more of both goods due to the increase in real income caused by the price decrease of X.

The total effect is the movement from point A to point D. As we can see from the graph, the quantity demanded of X and Y increases, and the consumer reaches a higher indifference curve at point D.

Therefore, the total effect of a decrease in the price of X from $2 to $1 is a budget expansion from AB to CD, resulting in an increase in the quantity demanded of both goods, totaling $25 ($15 more of X and $10 more of Y).

Refer to the Graph Below