A consumer considers gasoline an imperfect substitute to other things (curvy indifference curves). With a budget of 100 Euros, when gasoline costs 1 Euro per liter the consumer buys 30 liters of gasoline. After a tax raises the cost of gasoline to 2 Euros per liter, the consumer still buys 30 liters of gasoline. a) In an indifference curve diagram, illustrate this fact. b) Define the concept of substitution and income effect. d) Now, in your diagram disentangle the substitution and income effect of the (tax induced) price increase and show that this consumer considers gasoline an inferior good.

A consumer considers gasoline an imperfect substitute to other things (curvy indifference curves). With a budget of 100 Euros, when gasoline costs 1 Euro per liter the consumer buys 30 liters of gasoline. After a tax raises the cost of gasoline to 2 Euros per liter, the consumer still buys 30 liters of gasoline. a) In an indifference curve diagram, illustrate this fact. b) Define the concept of substitution and income effect. d) Now, in your diagram disentangle the substitution and income effect of the (tax induced) price increase and show that this consumer considers gasoline an inferior good.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter3: Preferences And Utility

Section: Chapter Questions

Problem 3.11P

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