Question

Using consumer theory, consider how households may respond to having their budgets squeezed as a result of the increase in prices of food, housing and energy. Make particular reference to and isolate any substitution and income effects (hint: you could make use of composite goods). A good place to start is to consider what type of goods these goods/services are, for example, whether they are normal or inferior goods; luxuries or necessities; and consider how your answer may vary with different income levels.

Answer 1

There is different effect of increase in price of food, housing and energy to different income group person .To understand this lets take the example of three people who are of different income group

Case-1

Effect of increase in price on low income group

Food and shelter is basic necessity and energy is also a necessity these days so any increase in the prices food, energy, shelter will effect on consumption of other commodities

If the price level increases of necessities then the first effect is going to be on a consumption of a luxury item for example if a person with low income group goes to a restaurant once in a month then he will stop going there second effect will be on a normal good and service for example he will buy less cloths and his expenditure on cloths will also decrease and he will use cloth for a longer period of time vefore discarding it because major part of income of low group people will be spent on food energy and shelter .there will be certain necessity on which budget distribution will remain unaltered for example medical expenditure .

Case- 2

Effect of increase in price on medium income group

If the price level increases of necessities then the first effect is going to be on a consumption of a luxury item for example if a person with medium income group goes to a restaurant four times in a month then he will go only two times or one time in a month depending upon price rise. The second effect can be on a normal good and service if curtailment of expenditure doesn’t compensate price increase the expenditure on normal goods and service will decrease for example they will use public transport instead of own vehicle. There will be certain necessity on which budget distribution will remain unaltered for example medical expenditure.

Case-3

Effect of increase in price on high income group

For a billionaire an increase in price of food shelter and energy wouldn’t affect much .It is very rare that he will decrease his expenditure on any other good because he has a past saving and increase in price of food shelter and energy will decrease his saving but it is very rare that it will change its consumption pattern or consumption expenditure on other goods and service.