Question

Which of the following scenarios is consistent with the law of demand?

a. The substitution effect is -2 and the income effect is +3.

b. The substitution effect is 0 and the income effect is +1.

c. The substitution effect is 0 and the income effect is +2.

d. The substitution effect is -2 and the income effect is +1.

e. none of the above

Answer 1

When we follow the law of demand, we study the inverse relation between quantity demanded of a good and its own price. Note that substitution effect and income effect determine the law of demand in that, the substitution effect is encourages consumer to buy less of the good whose price has increased and buy more of the other and that the income effect encourages consumer to reduce consumption of both due to lower real income.

Here law of demand works when substitution effect is greater than income effect so that price decrease increases quantity demanded and vice versa. SE > ME is possible only in case D

Hence, select D.