Question

(a) Using appropriate diagrams discuss the income and substitution effects of a price change in case of an inferior good.

06 Jul 2022
Answer :
Word Count : 1122

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The income effect expresses the impact of increased purchasing power on consumption, while the substitution effect describes how consumption is impacted by changing relative income and prices.

These economic concepts concern changes in the market and how they impact consumption patterns for consumer goods and services.

Different goods and services are affected by these changes in the market in different ways. Some products, called inferior goods, generally are purchased less whenever incomes increase. Consumer spending on normal goods typically increases with higher purchasing power, which is in contrast with inferior goods.

The income effect is the change in the consumption of goods based on income. This means consumers will generally spend more if they experience an increase in income. They may spend less if their income drops.

The effect doesn't dictate the kinds of goods consumers will buy. They may opt to purchase more expensive goods in lesser quantities or cheaper goods in higher quantities, depending on their circumstances and preferences.

The income effect can be both direct or indirect. When a consumer chooses to make changes to the way they spend because of a change in income, the income effect is said to be direct. For example, a consumer may choose to spend less on clothing because their income has dropped.

An income effect becomes indirect when a consumer is faced with making buying choices because of factors not related to their income. For instance, food prices may go up, leaving the consumer with less income to spend on other items. This may force them to cut back on dining out, resulting in an indirect income effect.

The marginal propensity to consume explains how consumers spend based on income. It is a ____ ____ ___ _____ ____ _____.
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Related Questions

 Consider the following Table which gives total cost schedule of a firm. Given that the average fixed cost of producing 2 units of output is Rs. 10. Find the total variable cost, total fixed cost, average variable cost, average fixed cost, short-run average cost, and short-run marginal cost schedules of the firm for the corresponding values of output.

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     1                        50

     2                        65

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