Dave consumes two normal goods, X and Y, and is currently at an optimum. If the price of good X falls, we can predict with certainty that
A)Dave will consume more of both goods because his real income has risen.
B)the substitution effect will be positive for good X and negative for good Y.
C)Dave may consume more or less of good X, but he will consume less of good Y.
D)the substitution effect will offset the income effect for good X.

Question

Quizplus · Accepted Answer

When the price of good X falls, it becomes relatively cheaper compared to good Y, causing Dave to substitute away from Y and increase his consumption of X. This is the substitution effect. However, the decrease in the price of X also increases Dave's real income, allowing him to purchase more of both goods. This is the income effect. The overall effect depends on the magnitude of the substitution and income effects. In this case, we can predict with certainty that the substitution effect will be positive for good X and negative for good Y (choice B), but we cannot be sure about the net effect on Dave's consumption of X and Y.

Dave Consumes Two Normal Goods, X and Y, and Is