Bob goes out to dinner three times per week, usually either to the local steak house or a Chinese restaurant in town. If the steak house were to raise its prices, Bob would probably (1) be less inclined to eat at the steak house and more inclined to eat at the Chinese restaurant when he did go out and (2) eat out fewer times per week because at the higher prices he cannot afford to eat out as much.
A) Part 1 is an example of the substitution effect, part 2 of the income effect.
B) Part 1 is an example of the income effect, part 2 of the substitution effect.
C) Part 1 is an example of the law of diminishing marginal utility, part 2 of the substitution effect.
D) Part 1 is an example of the proportions hypothesis, part 2 of the income effect.

Question

Quizplus · Accepted Answer

Part 1 is an example of the substitution effect because Bob is substituting one restaurant for another due to a change in price. Part 2 is an example of the income effect because Bob is eating out fewer times per week due to the higher prices, indicating a reduced purchasing power of his income.

Bob Goes Out to Dinner Three Times Per Week, Usually