Question

Suppose that Jim uses his budget to purchase 100 units of Good X and 100 units of Good Y. When the price of Good X rises, he purchases 55 units of Good X and 95 units of Good Y. An economist calculates his compensated budget and finds that in that scenario, Jim would buy 60 units of Good X and 105 units of Good Y. Calculate the income effect. (Remember to include a negative sign (-) if the effect reduces the quantity.)

Answer 1

Answer:

(- 5 units)

Explanation:

Given that,

Initial quantities:

x1 = 100 units and y1 = 100 units

If price of Good X rises,

Final quantities:

x2 = 55 units and y2 = 95 units

Compensated:

x3 = 60 units and y3 = 105 units

Income effect = Final demand - compensated demand

                       = x2 - x3

                       = 55 units - 60 units

                       = - 5 units