Gladys Loves Music and Spends Her Money Only on Tapes
Gladys loves music and spends her money only on tapes and compact discs. She is always willing to trade 2 tapes for 1 compact discs. Originally, music stores sold compact disc for $9 each and tapes for $5 each. Then the price of compact discs fell to $8 each. The change in her consumption of compact discs that resulted was
A) entirely due to the substitution effect.
B) entirely due to the income effect.
C) partly due to the income effect and partly due to the substitution effect.
D) due to the income effect for low incomes and the substitution effect for high incomes.
E) There was no change in her demand for compact discs.
A taxpayer says, "Sure I pay a lot of income tax, but I don't mind because I get back just as much money as I pay in." Assuming that his facts are correct, explain why the taxpayer's reasoning is faulty. Use a diagram to show that an income tax can make a person worse off even if he is rebated an amount of money equal to what he paid in.
Use a diagram to prove that in case there are two goods, the substitution effect of an increase in the price of good x reduces the demand for good x.
Draw two different diagrams, one illustrating the Slutsky version of income and substitution effects and the other illustrating the Hicks version of income and substitution effects. How do these two notions differ?