The increase in consumption of a good when its price falls is caused by two effects. What are these two effects? Explain the difference between these effects
What will be an ideal response?
The two effects are the substitution and income effects. According to the substitution effect, more is consumed when the price of a good falls because the price of the good in question is now lower relative to the prices of other goods. In addition, the fall in price increases the consumer's purchasing power causing the quantity demanded to increase for a normal good and decrease for an inferior good. This is the income effect. For most goods, the income effect is small relative to the substitution effect which is why the overall effect of a price decrease is an increase in quantity demanded.
You might also like to view...
If everyone pays a fixed dollar amount of tax, then the tax is a
A. regressive tax. B. personal tax. C. marginal tax. D. proportional tax.
Which of the following is an experiment which tests whether fairness is important in consumer decision making?
A) the preferential treatment game B) the behavioral experiment C) the ultimatum game D) the fair trade principle
Explain the difference between the following two expressions: Y = C(Yd) + I + G + CA(EP /P, Yd) and Y = C + I +G + CA
What will be an ideal response?
A $1 standard of 1985 is worth about $2.50 in today's dollars
Indicate whether the statement is true or false