Question

For each of the following, use the budget constraint/indifference curve diagram to show what happens to the demand curve for good X:

*note: each question requires two graphs -- one showing the indifference curves and one showing the demand curves

a) A change in preferences that favors good Y over good X.

b) An increase in the price of a substitute for good Y when good Y is a normal good

c) An increase in the price of a substitute for good X when good X is an inferior good

d) An increase in income when Y is a Giffen good

Answer 1

a) Indifference curve shows the various combination of items which would offer the same level of satisfaction to the consumers.

Demand curve is a downward sloping curve which indicates the units of goods demanded at a particular price point.

a) A change in preferences that favors good Y over good X.

Preference of Good Y would increase the number of units of Good Y in the preference combination and the number of units of Good Y demanded.

b) An increase in the price of a substitute for good Y when good Y is a normal good.

As the price of a substitute for good Y increases, people would prefer more units of Good Y and the demand of Good Y increases.

c) An increase in the price of a substitute for good X when good X is an inferior good

As the price of a substitute of Good X increases, the demand of Good X remains the same as it is an inferior good. The preference of Good X would also remains the same as it is an inferior good.

d) An increase in income when Y is a Giffen good

As the income increases, the demand of Giffen goods Y come down as people would substitute it with a normal good. The preference of Good Y also comes down compared to other Good.