U= x (x1, x2) = x1+ 2x2 Suppose that a recent scandal has resulted in bad...

U= x (x₁, x₂) = x₁+ 2x₂

Suppose that a recent scandal has resulted in bad publicity for Uber. The scandal has not affected your preferences. However, in response to the bad publicity, Uber has reduced their price to $0.40 per mile. You have a budget of $10, and riding with Lyft costs $1 per mile.

What is the substitution effect (SE) for Lyft rides following the price change?

Solutions

Expert Solution

The substitution effect refers to the change in demand for a good as a result of a change in the relative price of the good compared to that of other substitute goods. For example, when the price of a good rises, it becomes more expensive relative to other goods in the market.The change in consumption of one good as a result of a price change that makes the good relatively cheaper than other goods. What is the effect of the substitution effect on demand when a price declines? When the price declines, the substitution effect always leads to an increase in the quantity demanded.The substitution effect is the change in x* in going from A to C, while the income effect is the change in x* in going from C to B. To find C, use the original indifference curve and find the point of tangency with a fictitious budget constraint that has the new price ratio.

substitution effect. the change in the quantity of a good that a consumer demands when the good's price rises, holding other prices and the consumer's utility constant. income effect. the change in the quantity of a good a consumer demands because of a change in income, holding prices constant; affects buyer power.

The income effect states that when the price of a good decreases, it is as if the buyer of the good's income went up. The substitution effect states that when the price of a good decreases, consumers will substitute away from goods that are relatively more expensive to the cheaper good.

The law of demand states that quantity demanded increases when price decreases, but why? Two reasons why the demand curve slopes downward are the substitution effect and the income effect. The income effect states that when the price of a good decreases, it is as if the buyer of the good's income went up. The substitution effect states that when the price of a good decreases, consumers will substitute away from goods that are relatively more expensive to the cheaper good.

Rahul Sunny answered 1 year ago

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