The initial budget constraint (BC₁) shows the two friends' budget constraint when the price of an upscale dinner is $100. At this price, Rajiv andSimone would choose to consume five upscale dinners.Suppose that the price of an upscale dinner decreases to $50, shifting their budget constraint to BC2, which represents a new relative price of fivediner brunches per upscale dinner. (Hint: The blue line labeled H is parallel to BC₂ and tangent to I₁ at point M.)To maintain the level of happiness they experienced before the price decrease-that is, to consume at a point along the same indifference curve asthey were on initially (₁)-the income spent on upscale dinners and brunch at diners would now only have to be $However, in reality, ratherthan maintaining their original level of utility, the friends choose the optimal bundle along their new budget constraint. At this point, they areoff than before the price change in upscale dinners.On the following table, indicate which point movement represents the substitution effect and income effect for upscale dinners when the pricedecreases from $100 to $50. Then indicate the consumption change that results from each effect.Upscale DinnersSubstitution EffectIncome EffectConsumption ChangeRepresented By... (Quantity of upscale dinners)In this case, the price decrease of upscale dinners causes the real income of the two friends toSimone's real income and the direction of the income effect, upscale dinners areBecause of the change to Rajiv andfor the friends. 9. Income and substitution effectsRajiv and Simone are two friends living in Denver who love to try different restaurants in their city, but have specific preferences regarding venues forcertain meals. In particular, they like to eat out at upscale gastropubs for dinner and diners for brunch. On the following diagram, the purple curves1₁ and 12 represent two of their indifference curves for upscale dinners and diner brunches. Assume that the friends have a monthly budget of $1,000available to spend on going out to eat, and further, that the price of diner brunch always $10. Each labeled point represents tangency between abudget constraint and the corresponding indifference curve.DINER BRUNCHES005 6N|MBC,UPSCALE DINNERSHBC₂(?

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Accepted Answer

The income effect is the change in purchasing power that occurs as a result of a change in the price…