9708/42/M/J/22

A rational consumer is considered to be that person who makes rational consumption

decisions. In other words, the consumer who always seeking to maximize utility refers to
benefit and satisfaction getting from consuming the goods. Indifference curve is the curve that
shows the combination of 2 goods that give a consumer equal satisfaction. A budget line shows
all the combinations of both goods that can be purchased with a given income and given prices
of both goods
Normal good is a type of good that has positive income elasticity of demand, quantity
demanded fall as real income falls due to price increased.

The diagram above shows the effect of the rise in price of good B which is a normal good. The
initial optimum point E1 consuming quantity A1 and B1. An increase in price of B mean that
consumer will now have less purchasing power pivoting the budget line from BL1 to BL2. The
substitution effect is the move from E1 to E2 where less of good B is now being consumed as it
has become relatively more expensive compared to A. A rise in price also decreases the
consumer’s real income, this shifts them to a lower indifference curve IC2, the move from E2 to
E3 indicate a negative income effect as consumer decrease the consumption of both good. The
income effect and substitution effect in case of normal goods work in the same direction which
is negative -> result in an overall reduction in the consumption of good B.

An inferior good is a type of good that has negative income elasticity of demand, quantity
demanded rises as real income decrease.
{graph}
The diagram above shows the effect of an increase in price of good B which is an inferior good.
A rise in price of B is equivalent to a fall in real income and less purchasing power, the budget
line pivot o BL2. The substitution effect is shown by a movement from E1 to E2, quantity of
good B decrease as it’s relatively less affordable