Question

Suppose that consumers' preferences are well behaved in that properties 4-1 to 4-4 are satisfied. Furthermore, assume goods X and Y are normal goods and the price of good X decreases. Then the substitution effect will lead consumer to consume:
a. More of good X and more of good Y
b. Less of good X and more of good Y
c. Less of good X and less of good Y
d. More of good X and less of good Y

Answer 1

Answer:

d. More of good X and less of good Y

Explanation:

Normal goods are goods whose demands vary directly with income. If income rises, demand increases and if income falls, demand falls.

When the price of good X reduces, good X becomes cheaper and rational consumers would demand more of good X because it is cheaper and less of good Y which is now more expensive. This is known as the substitution effect.

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