Question #51483

Mr. Hassan’s demand function for rice is given by

X = 15 + M (10P) -1

Where X = amount of rice demanded, M = income of the consumer, P = price of rice.

Originally, the income of Mr. Hassan is 4,800 per month and the price of rice is kshs. 120/kg. If the price falls to kshs 100/kg, calculate to total effect (TE), substitution effect (SE) and Income effect (IE) emanating from this change in price

X = 15 + M (10P) -1

Where X = amount of rice demanded, M = income of the consumer, P = price of rice.

Originally, the income of Mr. Hassan is 4,800 per month and the price of rice is kshs. 120/kg. If the price falls to kshs 100/kg, calculate to total effect (TE), substitution effect (SE) and Income effect (IE) emanating from this change in price

Expert's answer

X = 15 + M (10P)^-1

M = $ 4,800 per month, P = $120/kg.

If the price falls to $ 100/kg:

1) the total effect TE = X2 - X1 = 15 + 4800/(10*120) - 15 - 4800/(10*150) = 0.8 kg

2) substitution effect SE = Xh - X0 = 15 + (4800*150/120)/(10*150) - 15 - 4800/(10*120) = 0 kg

3) income effect IE = X1 - Xh = 15 + 4800/(10*150) - 15 - (4800*150/120)/(10*120) = 0.8 kg

M = $ 4,800 per month, P = $120/kg.

If the price falls to $ 100/kg:

1) the total effect TE = X2 - X1 = 15 + 4800/(10*120) - 15 - 4800/(10*150) = 0.8 kg

2) substitution effect SE = Xh - X0 = 15 + (4800*150/120)/(10*150) - 15 - 4800/(10*120) = 0 kg

3) income effect IE = X1 - Xh = 15 + 4800/(10*150) - 15 - (4800*150/120)/(10*120) = 0.8 kg

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