Answers
A decrease in the price of normal goods would lead to a rise in the consumption of such goods. Following is a diagram:
- After fall in the price of good B, the budget line shifts outwards. Hence, now new equilibrium is established at indifference curve 2.
- After equivalent variation, we draw dotted parallel line, so that the budget line could touch old indifference curve 1.
- The movement of Q2 to Q6 shows the substitution effect.
- Gap between the Q6 and Q4 is called income effect.
- Both effects move in same direction.
Product A (units) Q2 Q6 Q4 Product B (units) Substitution Income effect effect Overall increase in the quantity demanded
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