Question

"A rational consumer prefers more of good x to less. If the price of good x rises and the prices of all other goods remain constant, then the consumer must necessarily demand less of x”. Is it true or false?

The answer states it false. But why can't it be true?

I found that due to the substitution effect, the new optimal bundle must be on the red area. And I thought the blue area shouldn't be solid due to the "revealed preference".

Could you check and help me with my proving process? Thank you very much!

koriginal budget original optimal --- - -

Answer 1

For every economic "good" good the consumer prefers more to less. In the case of economic "bad" goods, like pollution, the consumer prefers less to more. Every good is an economic "good" good is divided into two border groups: Normal and inferior. Among the inferior, there are special cases called the Giffen good.

A Giffen good is good with the positive sloping demand curve. That is as the price of the good rises the consumption of the good rises. This happens because for Giffen good the income effect outweighs the substitution effect. For the increasing, the price of an inferior good, substitution effect decreases the consumption and income effect increases the consumption. For Giffen good increases consumption so much that it outweighs the negative substitution effect and as a result, the consumption of the good rises with the price.

Therefore, even if the consumer prefers more to less, the rising price does not necessarily demand less of the good. Hence, the statement is False.