Question

You can spend $10 for lunch and you would like to purchase two cheeseburgers. When you get to the restaurant, you find out the price for cheeseburger has increased from $5 to $6, so you decide to purchase just one cheeseburger. This is best described as: 

Multiple Choice 

 a decrease in the buyer's reservation price.

 the substitution effect of a price change.

 an increase in the buyer's reservation price.

 the income effect of a price change.

Answer 1

Option B is the correct answer.

Substitution Effect vs Income Effect:

Consumption decisions are influenced by several factors. Substitution and Income effects refer to the impact of income and prices on how consumers change their buying patterns.

Answerand Explanation:

If the consumer buys one burger because of a price increase from $5 to $6, it is a case of the income effect of a price change. The consumer has not switched to another product due to the price increase. The price increase has made the $10 lunch budget inadequate to buy two burgers. In other words, the consumer is experiencing a lower effective income. Hence, it is an income effect price change. Option B is the correct answer.

The substitution effect is observed when consumers switch to other products as a result of relative price changes. For example, if the consumer buys a burger and a drink instead of two burgers, that would be an example of a substitution effect. In this example, there is no evidence of this. So, A is not the correct option.

Reservation price is the highest price that a consumer is willing to pay for a good. Based on the information provided, it is not clear what the reservation price is for the consumer. The consumer was willing to pay $6 for a burger but it does not tell us whether he/she would have been willing to pay even more if the price was higher. So, options C and D are not correct.