1. Problem Statement: Graph the Income Consumption Curve (ICC) for three cases and decompose the Price Effect for a normal good. 2. Income Consumption Curve (ICC) Cases: (i) Both X and Y are Normal Goods: - Point A is at lower-left. - Point B is up and right of A. - ICC is an upward-sloping smooth curve connecting A and B. - Explanation: "As income increases, consumption of both goods increases. Therefore, the ICC is an upward-sloping curve from the origin." (ii) Good X Normal, Good Y Inferior: - Point A. - Point B is right of A (more X) but lower (less Y). - ICC slopes upward but bends towards X-axis. - Explanation: "As income increases, consumption of the normal good (X) rises, but consumption of the inferior good (Y) falls. The ICC therefore slopes upward but is biased towards the X-axis." (iii) Good X Inferior, Good Y Normal: - Point A. - Point B is above A (more Y) but left (less X). - ICC slopes upward but bends towards Y-axis. - Explanation: "As income increases, consumption of the normal good (Y) rises, but consumption of the inferior good (X) falls. The ICC therefore slopes upward but is biased towards the Y-axis." 3. Decomposing the Price Effect for a Normal Good: - Initial budget line AB tangent to IC₁ at A with quantity Xₐ. - Price of X falls, budget line rotates outward to AB₁ tangent to IC₂ at C with quantity X꜀. - Draw dashed budget line A'B' parallel to AB₁ tangent to IC₁ at B with quantity Xᵦ. - Arrows: - A→C labeled "PRICE EFFECT" - A→B labeled "SUBSTITUTION EFFECT" - B→C labeled "INCOME EFFECT" - Explanation: "The total Price Effect (A→C) is decomposed into the Substitution Effect (A→B), which always leads to more consumption of the cheaper good, and the Income Effect (B→C), which for a normal good leads to a further increase in consumption."