The following figure shows a portion of a consumer's indifference map and budget lines.The price of good Y is $7 and the consumer's income is $700.Let the consumer begin in utility-maximizing equilibrium at point A on indifference curve I.Next the price of good X changes so that the consumer moves to a new utility-maximizing equilibrium at point B on indifference curve II.The income effect of the change in the price of X is
A)+12
B)+10
C)-10
D)+32
E)+42

Question

The following figure shows a portion of a consumer's indifference map and budget lines.The price of good Y is $7 and the consumer's income is $700.Let the consumer begin in utility-maximizing equilibrium at point A on indifference curve I.Next the price of good X changes so that the consumer moves to a new utility-maximizing equilibrium at point B on indifference curve II.The income effect of the change in the price of X is 
A)+12 
B)+10 
C)-10 
D)+32 
E)+42

Quizplus · Accepted Answer

In the original equilibrium at point A on indifference curve I, the consumer is spending all of their income on 7 units of X and 85 units of Y (point E on budget line BL1). When the price of X changes, the budget line pivots outward and becomes BL2. The new equilibrium is at point B on indifference curve II, where the consumer is spending all of their income on 6 units of X and 99 units of Y (point F on budget line BL2).

To determine the income effect, we need to hold the consumer's utility constant and calculate how much their purchasing power has changed. In this case, the consumer has moved from point E to point F, which represents a decrease in quantity demanded of X from 7 units to 6 units. Therefore, the income effect is negative because the consumer is buying less of X despite having more purchasing power.

To calculate the income effect, we need to find the difference in the amount spent on X between the two equilibria and divide by the original price of X (before the change):

Income effect = (6 - 7) / 5 x 7 = -10

Therefore, the answer is choice B, -10.

The Following Figure Shows a Portion of a Consumer's Indifference