Question

Consider the consumer only consumes two goods namely flour and potatoes. Potatoes are an inferior good. Do you think that flour can also be inferior goods? Give your reviews. If the price of flour falls, illustrate the impact on the consumption of flour and potatoes using substitution effect and income effect.

Answer 1

The "substitution effect" is the decrease in  product sale which is attributed to consumers switching to "cheaper alternatives" when its price increases. The "income effect" is the change in demand for a good/service caused by a "change in a consumer's purchasing power" resulting from a change in "real income".

Explanation:

• The consumer here is said to consume only 2 goods implying that there are only 2 goods which are consumed that is, potatoes & flour. Potatoes here is stated as inferior goods. Inferior goods are goods whose "demand decreases" when "consumer's income increases", & "demand increases" when "consumer income decreases", unlike normal goods, where the  the "opposite is observed". Normal goods are those goods for which the demand rises as consumer income rises. However, it is not given if flour is a inferior good or not. Presuming flour is not a an inferior good, then we can assume consumers consume more potatoes than flour, since the price of flour is on the higher side when compared to potatoes (substitution effect).
• Based on this, presently both commodities face a "downward sloping graph", i.e. the "higher the price" the "lesser will be the demand"  &  vice versa (substitution effect where consumer shifts to potatoes since the price of four is on the higher side when compared to potatoes). If the price of flour decreases the consumers increase his/her consumption of flour.
• If price of flour decreases , without change in consumer's income, consumer's would demand more flour as the purchasing power of consumer is increased due to decrease in price of flour. The income effect states that after the "price decline", the consumer will purchase the "same goods" as before, & still have money "left over" to buy more. Hence, a decrease in price causes an increase in quantity demanded. So, based on it, we can say that flour is a "normal good"
• However, if he price of flour remains the same and consumer's income increases, then consumers shift from potatoes to flour.The logic behind this consumer's behaviour is that since the consumer can afford flour owing to income increase, his affordability increases to purchase flour. Therefore, the consumer would switch his/her demand from potatoes to flour. Hence, potatoes, whose demand has "fallen" because of income increase, is the inferior good & flour is the "normal good" .

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discuss the income and substitution effect of a price change in case ...

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