Question

(unsure of selected answer)

Assume that a consumer has well-behaved preferences. Following a price increase for good 1, we observe that a consumer increases the quantity demanded for good 1. From this, we know that O The pure substitution effect increases the consumption of good 1 O The pure substitution effect and the income effect must reinforce one another O Good 1 must be an inferior good. O both a and c O None of the above

Answer 1

Ans) Substitution effect is when people choose an alternative for a particular good with increase in price of that good which is cheaper leading to fall in demand of that good. Substitute can be adequate replacements or an inferior good. Since nothing is said here about the price or change in price of other good and also the demand is rising with increase in price, this cannot be substitution effect.

It cannot be income effect as, income effect is when with increase in income, consumption of good increases and that good is normal good.

Inferior goods are goods whose demand fall with increase in income. Also with increase in price of inferior good, demand of inferior good rises as person is unable to afford the other good.. To understand it better, let us suppose that there is a poor farmer, he consumes meat and potato. When the price of potato increases , he cannot afford meat and hence will consume more potato.

So the answer is inferior good.