When the price of a good changes, the income effect can found by comparing the equilibrium quantities purchased:
A)the new budget line and a line parallel to the new budget line tangent to the old indifference curve.
B)on the old budget line and on the new budget line.
C)on the new budget line and a line parallel to the old budget line tangent to the new indifference curve.
D)on the old budget line and a line parallel to the old budget line tangent to the new indifference curve.

Question

Quizplus · Accepted Answer

The income effect is observed by comparing the equilibrium quantities purchased between the new budget line and a line parallel to the new budget line but tangent to the old indifference curve. This comparison isolates the effect of the change in purchasing power (or real income) on the quantity demanded, separate from the substitution effect.

When the Price of a Good Changes, the Income Effect