Microeconomics help.?

Question

I have this question that I don't get. It says , Using indifference curves and the budget line, explain the income effect, and derive the demand curve. I know you guys and gals can't draw the curves on here but can you try to explain the question a little better for me. Thanks heaps.

Answer 1

I'll give it my best shot:

First draw a budget line between goods X and Y, which will be a straight line between the X and Y axes.  This problem will be easier if you (1) start with a very large graph and (2) start with a flattish-sloped budget constraint.  Draw an indifference curve (Hint for drawing ICs: start at the tangency point, and draw half of the curve at a time.)

Now assume that good Y becomes less expensive.  This is, in effect, an increase in income, because you can now purchase more of good Y with your income.  Draw a steeper budget line and give yourself some room to draw another indifference curve.  You might have to play with it, but just make sure the tangency point is to the left of the first tangency point.

Draw a line that connects the two tangency points.  This is the demand curve.  The income effect explains how a change in price (or income) will affect consumption.  The link below shows what your graph should sort of look like.

http://ingrimayne.com/econ/MaximizingBeh...

Wikipedia also has a pretty decent explanation, it is sort of technical but the answer you are looking for is also there.  

http://en.wikipedia.org/wiki/Consumer_th...