horizontal axis; (3) Sketch these diagrams so that the substitution effect exceeds the income effect; the income

effect exceeds the substitution effect; and the two effects are equal.

One final note: The helpful dashed line can be drawn tangent to the new indifference curve, and parallel to the

original budget line, rather than tangent to the original indifference curve and parallel to the new budget line.

Some students find this approach more intuitively clear. The answers you get about the direction and relative

sizes of the substitution and income effects, however, should be the same.

Key Concepts and Summary

An indifference curve is drawn on a budget constraint diagram that shows the tradeoffs between two goods. All

points along a single indifference curve provide the same level of utility. Higher indifference curves represent

higher levels of utility. Indifference curves slope downward because, if utility is to remain the same at all points
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