=+8.3 In this chapter, we began by considering the impact of an increase in the price of gasoline on George Exxon, who owns a lot of gasoline. In this exercise, assume that George and I have exactly the same tastes and that gasoline and other goods are both normal goods for us.

A. Unlike George Exxon, however, I do not own gasoline but simply survive on an exogenous income provided to me by my generous wife.

a. With “gallons of gasoline” on the horizontal and “dollars of other goods” on the vertical, graph the income and substitution effects from an increase in the price of gasoline.

b. Suppose George (who derives all his income from his gasoline endowment) had exactly the same budget before the price increase that I did. On the same graph, illustrate how his budget changes as a result of the price increase.

c. Given that we have the same tastes, can you say whether the substitution effect is larger or smaller for George than it is for me?

d. Why do we call the change in behavior that is not due to the substitution effect an income effect in my case but a wealth effect in George Exxon’s case?