Potatoes are a Giffen good for Paddy, who has a small potato farm. The price of potatoes fell, but Paddy increased his potato consumption. At first this astonished the village economist, who thought that a decrease in the price of a Giffen good was supposed to reduce demand. But then he remembered that Paddy was a net supplier of potatoes. With the help of a graph, he was able to explain Paddy’s behavior. In the axes below, show how this could have happened. Put “potatoes” on the horizontal axis and “all other goods” on the vertical axis. Label the old equilibrium A and the new equilibrium B. Draw a point C so that the Slutsky substitution effect is the movement from A to C and the Slutsky income effect is the movement from C to B. On this same graph, you are also going to have to show that potatoes are a Giffen good. To do this,draw a budget line showing the effect of a fall in the price of potatoes if
Paddy didn’t own any potatoes, and only had money income. Label the new consumption point under these circumstances by D.