# Chapter 1. Figure It Out 5.3

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Figure A

Pavlo eats cakes and pies. His income is \$20, and when cakes and pies both cost \$1, Pavlo consumes 4 cakes and 16 pies (point A in Figure A). But when the price of pies rises to \$2, Pavlo consumes 12 cakes and 4 pies (point B).

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Figure B

Refer to Figure B. Separate the change in the consumption of pies into the substitution effect and the income effect.

### Question

The substitution effect of the price increase is sWNiRN4ZHUU= pies. The income effect is Iqg0WACpeMM=

To find the substitution effect, construct an “imaginary” budget constraint that is parallel to the new budget constraint but tangent to the original indifference curve. That budget constraint is shown as BC′, which is tangent to U1 at A′. Then, compare the original bundle to the bundle at the point of tangency. Pavlo consumes 16 pies at A, and 12 pies at A′, so the substitution effect is -4 pies. Then, determine the income effect by comparing Pavlo’s consumption of pies at A′ to his consumption of pies at B. At A′ he consumes 12 pies; at B he consumes 4, so the income effect is -8 pies. For further review see section “Decomposing Consumer Responses to Price Changes into Income and Substitution Effects”.

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Figure C

Refer to Figure B. Are pies a normal or inferior good? Are cakes a normal or inferior good?

### Question

Pies are a(n) 67oA3rZXG43lk5wa good. Cakes are a(n) SgLPN6jKiRGRj2Lm good.

The shift from BC′ to BC1 represents a decrease in overall purchasing power, or income: Both goods are less affordable; there is a parallel shift of the budget constraint, so relative prices are unchanged. As purchasing power decreases, Pavlo’s pie consumption falls from 12 (at point A′) to 4 (at point B). Because the decrease in purchasing power causes a decrease in consumption of pies, pies must be a normal good. Cake consumption, however increases from 10 at point A′ to 12 at point B. Because cake consumption increases as purchasing power decreases, cake must be an inferior good. For further review see section “Decomposing Consumer Responses to Price Changes into Income and Substitution Effects”.