Answer to Question #51329 in Microeconomics for dan

Question

Stella is an 8 year old that gets a monthly allowance of $10 from her parents. There are only two things that Stella likes to spend her allowance on: chocolate bars and packages of stickers. Assume that initially chocolate bars cost $1 each and packages of stickers cost $2 each. Suppose that as a result of the price change, the substitution effect caused Stella to increase her chocolate consumption by 4 chocolate bars. How big is the income effect? Can you say whether Stella considers chocolate bars to be a normal or an inferior good? Explain.

Answer 1

Stella gets a monthly allowance of $10. Pch = $1, Pps = $2. If as a result of the price change, the substitution effect caused Stella to increase her chocolate consumption by 4 chocolate bars, the income effect will be zero, because the change in consumption was only according to the substitution effect. We can't say whether Stella considers chocolate bars to be a normal or an inferior good, because we don't know the direction of the price change (increase or decrease). If the price decreased, then it is a normal good.