9. Income and substitution effects Paolo and Sharon are two friends living in Houston who love to try different restaurants in their city, but have specific preferences regarding venues for certain meals. In particular, they like to eat out at upscale gastropubs for dinner and diners for brunch. On the following diagram, the purple curves and 2 represent two of their indifference curves for upscale dinners and diner brunches. Assume that the friends have a monthly budget of $400 available to spend on going out to eat, and further, that the price of a diner brunch is always $5. Each labeled point represents tangency between a budget constraint and the corresponding indifference curve. ? 72 DINER BRUNCHES 50 C 40 H BC UPSCALE DINNERS The initial budget constraint (BCi ) shows the two friends' budget constraint when the price of an upscale dinner is $25. At this price, Paolo and Sharon would choose to consume six upscale dinners. Suppose that the price of an upscale dinner increases to $50, shifting their budget constraint to BC2, which represents a new relative price of ten diner brunches per upscale dinner. (Hint: The blue line labeled H is parallel to BC2 and tangent to /j at point B.) To maintain the level of happiness they experienced before the price increase-that is, to consume at a point along the same indifference curve as they were on initially (/1 )-the income spent on upscale dinners and brunch at diners would now have to be |$ . However, in reality, rather than maintaining their original level of utility, the friends choose the optimal bundle along their new budget constraint. At this point, they are off 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 price Increases from $25 to $50. Then indicate the consumption change that results from each effect. Consumption Change Upscale Dinners Represented By... (Quantity of upscale dinners) Substitution Effect Income Effect In this case, the price increase of upscale dinners causes the real income of the two friends to . Because of the change to Paolo and Sharon's real income and the direction of the income effect, upscale dinners are for the friends