Question

What are the income and substitution effects of an increase in the price of food, if
a person's preferences could be represented by the utility function
U(F;C) = 2 (under root)(F) + C
where F is her consumption of food and C is her consumption of clothing?

I don't understand how to answer this without any numerical values

Answer 1

At first, try to understand what are income and substitution effects.

1. The income effect is the change in consumption patterns due to the change in 'purchasing power'. This can occur from income increases, price changes, or even currency fluctuations. Goods typically fall into one of two categories: normal and inferior. These categorizations relate consumption of a good with a particular individual’s income. Normal goods increase in consumption as income increase while inferior goods decrease as income increases.

Food is an inferior good. When the price of food increases, you can buy less quantity of the food for the same money income, thus reducing your utility.

U(F;C) =

In the present context, no information is given about change in the price of clothing. So, there is an overall fall in Utility.

2. Substitution Effect: The substitution effect is the change in consumption patterns due to a change in the relative prices of goods.

When the price of food increases and price of cloth remains unchanged, Utility can be maximised by demanding more of cloth than food. (since cloth is relatively less priced now). Substitution effect refers to substituting a relatively less priced good for a more priced one.