Discuss the substitution, income, and total effects of a price change for Coke f
ID: 1167315 • Letter: D
Question
Discuss the substitution, income, and total effects of a price change for Coke for Mary, who views Coke and Pepsi as perfect substitutes.
Assume for simplicity that the price of a can of Coke increases such that it becomes twice that of a can of Pepsi.
The size of the substitution effect (in terms of Coke) is _____ cans, the income effect is ______ cans, and the total effect is ______ cans.
Please note, this is all of the information listed in the question. I would assume the blue L1 is the original budget line, and e1 is the original equilibrium. I also assume I1, I2, and I3 are the 3 different income scenarios.
2 ke 15- 14 13- 12 10- he as 7 1 2 e1 0 1 2 3 45678 9 10 11 12 13 14 15 Coke, Cans per weekExplanation / Answer
Given coke and Pepsi are perfect substitutes. Let x is the quantity of coke and y be the quantity of Pepsi. Price of coke is px and price of Pepsi is py such that the original budget line is px.x+py.y=m where m is money income. The original budget line is given and three indifference curves are also given where the original optimal bundle is e1 where only coke is consumed at 12units as one good completely substitutes for the other good. The slope of the budget line is px/py
If the price of coke increases then the budget line would become steeper and the original budget line will pivot to the left around e1 and the consumer would completely substitute coke with Pepsi as coke has become expensive. The total effect, in this case, is substitution effect which implies from 12 cans of coke to 4 cans of coke and the new equilibrium will be 8 cans of Pepsi as when budget line changes, the corner solution where the budget line intersects the indifference curve is IC2