Question

1.) If a consumer is compensated for the income effect, that is you give him enough money to keep him on the original indifference curve when the price of a good increases, his demand can never slope upward. Is this true or false, and why?

2.) “For two goods that are perfect complements the substitution effect is always zero.” Is this true or false and explain how you know?

Answer 1

Ans 1) Income effect is the effect on the quantity demanded exclusively as a result of change in money income. A change in demand caused by a change in purchasing power of a consumer is called income effect.

• Income effect can either be positive or negative.
• Income effect for a good is said to be positive when with the increase in income of the consumer, his consumption for the good alsoi ncreases.

Income effect is said to be negative when the income of the consumer increases, but the consumer reduces his consumption of that good. Such goods for which income effect is negative are called inferior goods.

When the price of a good increases his demand for that good decreases. As a result his demand curve can never be an upward sloping. It is true because quantity demanded and price is inversely related for normal goods.

Ans 2.) For two goods that are perfect compliments the substitution effect is always zero. It is true.

Goods which are consumed together to satisfy a want are called complementary goods. Eg: Petrol and Bikes. The relationship between the price of a good and demand for its complementary good is inverse. If there is an increase in the price of a complementray good, the demand for its complement good decreases.

Eg: The demand for petrol may decrease if there is an increase in the price of bikes.

Substitution effect means the change in the purchase of a good as a consequance of a change in relative price alone, real income remaining the same.

As a result of substitution effect the consumer remains on the same indiffernce curve.