The Overall Effect as the Sum of Income and Substitution Effects

Consider a consumer's choice between two goods. Initially, the consumer chooses bundle A on their budget line. After the price of one good decreases, the consumer's new optimal choice is bundle B. To analyze this change, a hypothetical budget line is constructed that is parallel to the new budget line and tangent to the consumer's original indifference curve at bundle C. What economic principle is isolated by the consumer's change in consumption from bundle C to bundle B?

Applying the Income Effect to Consumer Choice

A consumer's optimal choice of two goods is analyzed using indifference curves and budget lines. When the price of one good falls, the consumer moves from an initial optimal bundle to a new final optimal bundle. To separate the impact of this price change, a hypothetical budget line is drawn that has the same slope as the new budget line but is just tangent to the original indifference curve. Which of the following statements correctly identifies the income effect in this graphical analysis?

In the graphical decomposition of a price change's effect on consumer choice, a hypothetical intermediate choice (Point C) is identified on the consumer's original indifference curve, but at the new relative price level. The movement from the initial choice (Point A) to this hypothetical choice (Point C) represents the change in consumption patterns caused purely by the change in the consumer's purchasing power.

Isolating the Purchasing Power Effect

Interpreting a Component of a Price Change

In an analysis of a consumer's response to a wage change, the initial optimal choice is point A and the final choice is point B. A hypothetical point C is used to decompose the total change into two distinct effects. Match each economic concept to the graphical movement that represents it.

In a graphical model showing a consumer's response to a price change, the total effect on consumption is broken down into two components. The initial choice is at point A, and a hypothetical intermediate choice is at point C. If the movement from point A to point C is defined as representing the pure income effect, what must be true about the relationship between the budget lines associated with these two points?

An economist analyzes an individual's response to a wage increase, decomposing the change in hours worked. The initial choice is point A, and a hypothetical point C is used to isolate one component of the total change. The economist makes the following statement: 'The movement from point A to point C represents the income effect, showing the individual chooses more free time. Because this isolated effect shows a preference for more free time, it must be stronger than the substitution effect.' What is the fundamental error in this reasoning?

Critiquing an Economic Analysis of Consumer Choice