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Suppose that Harry has a £30 weekly budget for his evening meals which he spends entirely on fish & chips. Harry never eats fish without chips and vice versa and with one portion of fish he always takes one portion of chips. If a portion of fish and a por Essay Example

ECON101 ASSIGNMENT 1 2016

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Suppose that Harry has a £30 weekly budget for his evening meals which he spends entirely on fish & chips. Harry never eats fish without chips and vice versa and with one portion of fish he always takes one portion of chips. If a portion of fish and a portion of chips each originally cost £3, what will be the income and substitution effect if the price of a portion of chips decreases to £2? Explain and illustrate your answer graphically using the indifference analysis.

Fish and chips in the case of Harry are complementary goods. Good A is complementary to good B if the increase in demand of good A causes an increase in the demand of good B[ CITATION Arm95 l 1033 ]. This condition is reversible such that if A complements B then B complements A.

Assuming that marginal utility of money is unchanged, according to the above meaning it follows that if the price of portion of chips decreases and as a result the amount of fish portion demanded by Harry will increase, when this happen, the marginal utility will increase if this occurs then fish and chips are complementary and consequently increase the amount of fish demanded.

According to total price-effect approach, since fish is a complementary good to chips, decrease of the price level of chips will mean that the amount demanded for chips to go up, the amount of a portion of fish will automatically increase as well.

Now, by decrease of price level of chips and adjustment for income variation, there is an increase in the amount of chips, and the amount demanded of fish also goes up as a result of the substitution effect as the two goods complement each other. The increase of amount demanded of fish and chips as caused by the decrease in the price of chips means that the two products complement each other and are substitute of other goods in the market represented by money[ CITATION WBr12 l 1033 ].

Harry’s position has not improved more than before; we assume that his income remains the same as before in the period that the price of a portion of chips decreases. The main cause of the increase of both the goods is mainly the substitution effect. Fish is a complement of chips as clearly seen when there is increase in the marginal rate of chips after chips is exchanged for money thereby leaving the consumer at a state that is no better than the previous one.

Assuming Harry is in a state of equilibrium with a portion of chips, a portion of fish and money where money here represent all other goods in the market and all three derive a marginal rate that is equal to their prices where the price of money is unity. After the price of chip decreases, Harry will prefer to substitute money for chips and with the increased amount of chips demanded, Harry will want to exchange money for fish. An increase the amount of fish demanded by Harry has increased due to the decrease in the price of chips. Fish then is a complementary good to chips since the increase in the demand for chips has led to the increase of the amount demanded for fish.[ CITATION Bar82 l 1033 ].

Complementary goods case cannot be analyzed on a two-dimensional indifference curve illustration. In the analysis of two complementing good one must bring another product in to the picture for it to make sense. After bringing the third product into the picture then one can be able to substitute the two complementing goods against the third product[ CITATION Pau13 l 1033 ].

Two complementary goods are shown in a study of an indifference curve which is right angled meaning that the two goods are demanded in fixed quantities. If there is a decrease in the price of a complementary good considering that the income remains constant then the volume demanded complementing products will remain the same amount.

In the figure below we can observe that due to the falling price of good X the price level moves to PL2from the initial price level PL1. According to the figure, Harry will move from an output equilibrium of Q to the new equilibrium Q’ as caused by the decrease I the price if chips. At the new Equilibrium Q’, Harry will demand higher amounts of both the fish and chips portions.

Suppose that Harry has a £30 weekly budget for his evening meals which he spends entirely on fish & chips. Harry never eats fish without chips and vice versa and with one portion of fish he always takes one portion of chips. If a portion of fish and a por

The initial income position is shown by the line AB and the difference of money as brought about by the decrease in the price of chips is shown by the gap PA in the Y axis which is the difference in compensation. Equilibrium is attained when the indifference curve is tangent to the price line. When the price line shifts, so does the equilibrium point of demand of both the complementing goods.

The effect brought about by substitution is zero but nonetheless, as shown in the graph above, the amount demanded of one product will increase as a result of a decrease in the price of the other compensating good.

For harry to be indifferent it is important that when the price of a complementing product decrease the amount demanded of substitute product must decrease when the amount demanded for the complementing goods increase.

Same quantities of produce will be demanded by Harry irrespective of the price of the other complementing good. As the level of demand remains the same, the income-consumption curve is obtained by linking the utility maximization point where budget constraint equals the indifference points. The demand of one good is affected by the amount demanded of another good.

For fish and chips are complements of each other than, Harry is no better having more chips than fish because the he will not be getting maximum utility. And He will be no better either having more fish than chips. This shows that the marginal utility of these two good is either zero or infinite.

Bibliography

Allen, B., 2012. Managerial Economics: Theory, Applications, and Cases / Edition 8. s.l.:Norton, W. W. & Company, Inc..

Armstrong, M., 1995. The Job Evaluation Handbook. The Cromwell Press.

Baron, J., 1982. Intelligence and Personalit. Handbook of Intelligence. Cambridge: Cambridge University Press.

Baye, M., 2013. Managerial Economics &Amp; Business Strategy / Edition 8. s.l.:McGraw-Hill Higher Education.

Keat, P., 2013. Managerial Economics / Edition 7. s.l.:Pearson.