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    income effect

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    a.Jean has an income of $25,000 (after taxes). When the price of gasoline is $1.75 per gallon, Jean buys 1,000 gallons. Putting gasoline on the horizontal axis and "other goods" on the vertical axis, and assuming a unit of "other goods" costs $1, draw Jean's budget constraint and show the equilibrium.

    I think the budget constraint in this case will be:

    1.75x + y = 25000

    but not sure about equilibrium.

    If the price of gasoline rises to $2.50, while Jean's income remains at $25,000. Draw the new constraint and show a possible new equilibrium choice. For the choice you have drawn, illustrate the income effect and substitution effects of the price change. As you have drawn it, is the income effect positive or negative? (Hint: you can assume that both goods are normal).

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    Solution Summary

    The income effect is explicated.

    $2.19