Income And Substitution Effects Using Indifference Curve

Meanwhile the income effect shifts the optimum to a new indifference curve i 2 at the intersection of the new budget constraint c as indicated by the green arrows.

Income and substitution effects using indifference curve. Suppose the price of x falls so that his new budget line is pq 1. Indifference curves income and substitution effects for inferior goods. A graph showing the substitution effect associated with a decrease in the price of good x. In terms of the graph the substitution effect is shown by rotating the original budget line around the initial indifference curve until it achieves its new slope.

The movement from pt. X 1 to pt. This movement from q to s on the same indifference curve ic represents the substitution effect since it occurs due to the change in relative prices alone real income remaining constant. With the fall in the price of x the real income of the consumer increases.

If the amount of money income which was taken away from him is now given back to him he would move from s on indifference curve ic to r on a higher indifference curve ic 2. The substitution effect moves the consumer from the bundle labeled a to the bundle. X 2 involved a change in the marginal rate of substitution i e. The substitution effect is explained in figure 12 17 where the original budget line is pq with equilibrium at point r on the indifference curve i 1.

The substitution effect moves the initial optimum a on the initial indifference curve i 1 to point b as indicated by the black arrows. In this revision video we look at the income and substitution effects for an inferior good. When the price falls the substitution effect is never perverse it will always cause more to be demanded. At r the consumer is buying ob of x and br of y.