AQA A-Level Economics 2025/6

Economics • A-Level

Question 1 of 114

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[DIAGRAM: Indifference curves with budget constraint]

With reference to the diagram, explain how a rise in the price of good X affects the consumer’s equilibrium. In your answer, identify the original and new equilibrium points, describe the movement of the budget line, discuss the substitution and income effects, and comment on the change in the consumer’s welfare.

Hint: Look at how the budget line pivots when the price of good X increases and note the new tangency point on a lower indifference curve.

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Correct answer: The diagram shows an initial budget line (BL1) tangent to indifference curve IC1 at point A, representing the consumer’s original equilibrium where the marginal rate of substitution (MRS) equals the price ratio (Px/Py). When the price of good X rises, the budget line pivots inward around the intercept on the Y‑axis, becoming a steeper line (BL2). The new, lower affordable combinations force the consumer to choose a lower indifference curve (IC2). The new equilibrium is at point B, where BL2 is tangent to IC2 and MRS = new Px/Py. The movement from A to B reflects a substitution effect (the consumer substitutes away from the relatively more expensive good X towards good Y) and an income effect (the rise in Px reduces real income, further reducing consumption of both goods). Because IC2 lies to the left and below IC1, the consumer’s utility falls, indicating a loss in welfare. The overall effect is a decrease in the quantity of good X consumed and a possible change in the quantity of good Y depending on the relative sizes of the substitution and income effects.

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Correct Answer

The diagram shows an initial budget line (BL1) tangent to indifference curve IC1 at point A, representing the consumer’s original equilibrium where the marginal rate of substitution (MRS) equals the price ratio (Px/Py). When the price of good X rises, the budget line pivots inward around the intercept on the Y‑axis, becoming a steeper line (BL2). The new, lower affordable combinations force the consumer to choose a lower indifference curve (IC2). The new equilibrium is at point B, where BL2 is tangent to IC2 and MRS = new Px/Py. The movement from A to B reflects a substitution effect (the consumer substitutes away from the relatively more expensive good X towards good Y) and an income effect (the rise in Px reduces real income, further reducing consumption of both goods). Because IC2 lies to the left and below IC1, the consumer’s utility falls, indicating a loss in welfare. The overall effect is a decrease in the quantity of good X consumed and a possible change in the quantity of good Y depending on the relative sizes of the substitution and income effects.

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