Trevor always begins the day with a strawberry milkshake (milk (x1) and strawberries (x2) mixed in proportion 1:5). His income is equal to m=200, and one strawberry costs p2=1. Suppose the price of milk drops from p1=15 to p1=5. We are going to decompose the total effect into substitution effect and income effect. a) What is the total change in demand for milk? b) What is the substitution effect? c) What is the income effect?

Check the explanation

Explanation:

Going by the question that the proportion of milk and strawberry for milk shake is 1:5.

If amount of milk is to be X1 that means the quantity of strawberry (X2) will be 5*X1, i. e., X2=5X1 ... Equation 1

And in addition, the milk and strawberry are complementary consumables as strawberry is of no use without milk and vice versa.

Budget equation will be as follows:

P1*X1+P2*5X1=M ... Equation 2

Given M=200, P1=15 & P2=1

Putting values in Equation 2

15*X1+1*5X1=200

X1=10 & X2=50 (from equation 1)

Answer a)

With change in P1 from 15 to 5

Again putting values in Equation 2

5*X1+1*5X1=200

X1=20 & X2=100.

The total change in the demand of milk will increase from 10 units to 20 units.

Answer b)

Strawberry and milk are complementary goods here for that reason there would be no effect on substitution.

Answer c)

Since there will be no effect on substitution, total effect will be equal to income effect.