Prof.

Gustavo Indart
Department of Economics
University of Toronto

ECO 100Y
INTRODUCTION TO ECONOMICS

Solutions to Problem Set 4

1. a. b.

Oranges Slope = – 5

200 A

150 B Slope = – 2

40 75 Apples

c. Given the prices in part c., Jane will move from point A to point B and thus it will
substitute apples for oranges.

d. The MRS at point B is 2 (equal to the absolute value of the slope of the isocost
tangent to the indifference curve at point B).

e. The absolute value of the slope of the isocost line tangent to the indifference
curve at point A is 5 (equal to the MRS). Since the slope of an isocost line is the
relative price of apples, the price of apples must be $5 if the price of oranges is
$1.
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2.

Y a. Y b. Y c.

A B

B A
B

X X X

a. If X is an inferior good, then the individual will consume a larger quantity of X

when her income falls.
b. If the prices of both X and Y increase in the same proportion, then the isocost
line shifts down but its slope doesn’t change. If we assume that both X and Y
are normal goods, then the individual will consume a smaller quantity of both
X and Y.
c. If the price of X falls, the individual will consume a larger quantity of X (unless
X is a Giffen good). If the demand for X is inelastic, then the total expenditure
on good X will decrease as X increases. That means that the total
expenditure on good Y will increase, and thus the quantity consumed of good
Y will increase as well.

3.

Y Normal Y Inferior Y Income-independent

A A A
Only if pizza is a normal good will Syema consume fewer units of pizza. She will
consume more pizza if pizza is an inferior good, and the same amount as before
if pizza
B is an income-independent good. B

X X X
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Only if pizza is a normal good will Syema consume fewer units of pizza. She will
consume more pizza if pizza is an inferior good, and the same amount as before
if pizza is an income-independent good.

4.
Y
Substitution effect is
equal to the change in
500 quantity demanded of
good X from point A to
point B

400
Income effect is equal to
the change in quantity
demanded of good X
from point B to point C
300

A C
B
200 Note: X0 = 100
and X1 = 200

100

B0 B1

0
0 100 XS 200 300 400 500 X

s.e. i.e.

Total Effect
P

50

25

100 200 X
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5. The statement is false. It is true that the substitution effect is always in the opposite
direction to the price change (a rise in P Æ a fall in Qx). However, the income effect
can be either in the opposite direction (normal good) or in the same direction (inferior
good) as the price change. Demand will still be downward sloping for an inferior
good - unless it is a Giffen good - provided the Substitution effect is greater than the
Income Effect. Therefore draw the Substitution Effect and pick any point on the new
budget line between Xs and Xo to have the Income Effect in the same direction as
Price and the Demand Curve downward sloping.

6.
a. The statement is false. It would be correct if both meat pies (good Y) and fish
steak (good X) were normal goods (Figure 1 – ICC with a positive slope). If one
of the goods were an inferior good, say fish steak, then Sean would increase his
consumption of fish steak but decrease her consumption of meat pie (Figure 2 –
ICC with a negative slope). And if one of the goods were an income-independent
good, say fish steak again, then Sean would decrease his consumption of fish
steak but leave his consumption of meat pie unchanged (Figure 3 – ICC vertical).
Note that in the last two cases meat pie must be necessarily a normal good.

Figure 1: Figure 2: Figure 3:

X and Y are X is inferior and X is income-indep.
both normal Y is normal and Y is normal
Y Y Y

ICC ICC ICC

X X X

b. The statement is false because if cod cakes are a normal good for Kerry and an
inferior good for Murphy, then the increase in Kerry's income and the decrease in
Murphy's income will both result in an increased quantity of cod cakes. This can
be seen in the diagram on the next page.
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Cod Cakes Cod Cakes

c. The Statement is true.

The good is inferior if the substitution
effect works in the opposite direction to
the income effect. Demand will still
have 'negative elasticity of demand'
(i.e., downward sloping) if the
substitution effect is greater than the
income effect as it is here.

d. The substitution and income effects move in opposite direction for an inferior good
when there is a change in price. (A fall in price causes the consumer to buy more of
the now relatively cheaper good and a rise in price always causes the consumer to
buy less of the now relatively dearer good, regardless of the type of good. The
direction of the income effect however depends on whether the good is normal or
inferior). Although the substitution and income effects move in opposite directions,
the demand curve is still downward sloping for an inferior, not a Giffen, good
because the substitution effect is greater than the income effect. The demand curve
for this inferior, non-Giffen, good is more inelastic though than that of a normal good.
The graphs in the previous questions should be sufficient to judge the correctness of
your graph here.