Suppose the price of potatoes falls and we observe a decrease in an individual's purchases of potatoes.Which of the following can we infer?
A)The substitution effect outweighs the income effect.
B)The income effect just offsets the substitution effect.
C)The income effect is negative and outweighs the substitution effect.
D)The income effect is positive and exceeds the substitution effect.
E)The income effect is negative and reinforces the substitution effect.

Question

Quizplus · Accepted Answer

The decrease in purchases of potatoes despite the fall in price implies a negative income effect, as the individual's purchasing power has decreased. The fact that this negative income effect outweighs the positive substitution effect (resulting from the lower price of potatoes) suggests that the individual is sensitive to changes in income and considers potatoes as a normal good.

Suppose the Price of Potatoes Falls and We Observe a Decrease