1. This question is designed to test your knowledge of Hicks – Allen indifference curve analysis (ICA)

1. Using separate appropriate diagrams in each case show the effect on consumer’s equilibrium in the following circumstances. Begin from the following: the consumer has an income of £100; they face two products, fish and beans, which cost £5 and £3 respectively. They prefer fish (you decide by how much).

1. Their income goes up by 10%. Assume both fish and beans are normal

The consumer’s income has increased by 10%, thus increasing their income from £100 to £110; this has increased their disposable income and spending power. The consumers spending budget is represented by the budget line (or budget constraint). It gives the budget constraint for the individual’s current level of income. The consumer’s preference is represented by an indifference curve. Indifference curves represent all the combinations of the market goods that provide the consumer with the same level of satisfaction. The indifference curves are placed along the budget constraint, depending on the consumer’s preference of goods, and how much the consumer is willing to substitute more of one good for another.

Due to the consumer’s income having gone up, the budget line and indifference curve shifts outwards. Being that they are normal goods, it simply means that they buy more of the same good because they have more income. When income increases people can simply afford more of X and Y, the slope shifts outwards and remains unchanged.

There are many different points on the budget constraint. The budget constraint shows the maximum or minimum amount of goods the consumer can purchase with their given income. At the different points on the budget constraint, the consumer is able to purchase different degrees of utility. Within the line you are within your income and above the line is not possible, the expenditure is not within your reach.

If all the previous income were spent on fish you would be able to purchase 20 fish, and if all previous income were spent on beans you would be able to buy 33 beans. However the income was increased, therefore the spending power, so the consumer was instead able to purchase up to 22 fish or 36 beans. Because the budget line has shifted outwards to accommodate the increase, it means that the equilibrium has also increased from 16.5 beans and 10 fish, to 18 beans and 11 fish. Due to the fact that 16.5 is not a whole ...