Figure 17-3
-Refer to Figure 17-3.Which of the following is true at W0?

Question

Figure 17-3 
-Refer to Figure 17-3.Which of the following is true at W0?

Quizplus · Accepted Answer

At W0, the consumer is consuming at point A which is on the original budget constraint BC. When the price of X falls, the consumer moves to a higher indifference curve IC1 and reaches the new budget constraint BC1 tangent to IC1 at point B. The movement from A to B can be decomposed into two effects- substitution effect and income effect. The substitution effect is the movement from A to C (where the consumer buys more of X) whereas the income effect is the movement from C to B (where the consumer buys less of X but more of Y due to an increase in real income). The slope of BC1 is less steep than BC, indicating that the substitution effect dominates the income effect. Hence, the answer is B -the substitution effect is larger than the income effect.

Figure 17-3 -Refer to Figure 17-3.Which of the Following Is True at Is