the higher price will push the decision-maker down to a lower level of utility, represented by a lower

indifference curve. But at this stage, draw only the new budget set. See Figure B8.

FIGURE B7

FIGURE B8

Step 3. The key tool in distinguishing between substitution and income effects is to insert a dashed line,

parallel to the new budget line. This line is a graphical tool that allows you to distinguish between the two

changes: (1) the effect on consumption of the two goods of the shift in prices—with the level of utility remaining

unchanged—which is the substitution effect; and (2) the effect on consumption of the two goods of shifting

from one indifference curve to the other—with relative prices staying unchanged—which is the income effect.

The dashed line is inserted in this step. The trick is to have the dashed line travel close to the original choice A,

but not directly through point A. See Figure B9.
530 B • Indifference Curves

FIGURE B9
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