Micro Economic - Assignment Example

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Income effect is the change in the consumption pattern observed with the utility level constant, which is the result of change in the prices of the goods and services. For a utility maximizing consumer, the effect of the change in price (that is a decrease or increase in…
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Download file to see previous pages A shift in the budget line along the bundle A is shown in the figure. The shift in budget line is parallel that indicates the fact that with a decrease in price of good X, the consumers’ real income increases. Furthermore, this implies that the consumer can now afford more goods and services as compared to the previous condition. Therefore, the parallel shift of the budget line and income effect shifts the consumer to a higher utility level. The movement from A to point B that depicts the effect of fall in price of good X. In case of normal goods, the consumption increases with the rise in income. On the other hand, in case of inferior goods, consumption falls with the rise in income (Arnold 261-265).
2) The change in price represents change in consumption pattern. A consumer is in a better position when consumption is located on a higher indifference curve, which indicates to a consumer’s response to the change in price of goods with respect to its nature. To be noted in this context, price effect is positive in case of normal goods. As positive income change causing shift in the budget line refers to its movement to a higher utility curve, the upward movement indicates that the consumer can purchase larger quantity of goods with same amount (Arnold 261-265). The change in consumption pattern is depicted as a shift in the budget line to a higher position as shown the figure-2 below.
3) Income effect is primarily considered as the result of the change in income earned by an individual. The effect can be positive as well as negative with respect to the type of goods. In case of normal goods, the income effect is positive but for inferior goods, it is negative. With the increase in income earned, preference for inferior goods decreases among consumers and so, the consumers become more likely to purchase substitutes. It is in this context that the shift in consumer preferences gives more satisfaction to the consumers as can be observed with reference to ...Download file to see next pagesRead More
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