Question

The income effect of a price change is described by which of the following statements?

Group of answer choices

a When the price of a good falls, consumers will now substitute this lower priced good for more higher-priced goods.

b The income effect shows how a change in income at a given price will affect the quantity of a good purchased

c When the price of a good falls, consumers have an implicit increase in income and can now buy more of the good.

d The income effect is the relative change in the amount of a good consumed when the price of another good changes.

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Answer 1

We will examine all the options.

Option a) states that when the price of a good falls, consumers will now substitute this lower priced goods for more higher priced goods. However, this statement is incorrect as when price of a good falls, consumers tend to consume more of this good compared to the other good. Also, this doesn't show income effect.

Option b) states that how a change in income will affect the quantity of good purchased. However, income effect does not happen when income changes. Instead, a change in price of a good is decomposed into two effects i.e., substitution effect and income effect.

Option c) states that when the price of a good falls, consumers have an implicit increase in income and can now buy more of the good. This option correctly represents income effect.

Option d) states that the income effect is the relative change in the amount of a good consumed when the price of another good changes. This is incorrect as the above statement is the definition of substitution effect.

Hence, option c) is the correct answer.