Question

Suppose the price of rice increases and you view rice as an inferior good. The substitution effect results in a ________ change in rice consumption, and the income effect leads to a ________ change in rice consumption.
A. negative, negative
B. negative, positive
C. positive, negative
D. positive, positive

Answer 1

Answer:

Suppose the price of rice increases and you view rice as an inferior good. The substitution effect results in a ________ change in rice consumption, and the income effect leads to a ________ change in rice consumption.

B. negative, positive

Explanation:

The substitution effect in economics represents the relation between the prince change in a product with the consumption rate. So, in our case, it would result in a negative effect if it is considered as an inferior good. while the income effect is the concept that explains the consumption change thanks to the acquisitive power available for the consumer. Resulting in a positive change in rice consumption due to the lower price of rice.

Answer 2

Answer:

B. negative, positive

Explanation:

Substitution effect : Price rise of a good makes it relatively expensive, decreases its demand. Price fall of a good makes it relatively cheap, increases its demand.

So: Substitution Effect is always negative as per above explanation.

Income Effect : Price rise of a good decreases real income/ real purchasing power of consumer & reduces demand of all goods. Price fall increases real purchasing power & increases demand of all goods.

Income effect is positive in case of Normal Goods, normal good demand is positively related to income. The effect is negative in case of inferior goods, inferior good demand is negatively related to income.

Hence: Price rise of rice - Substitution effect results in negative change  in rice consumption.  {∵substitution effect always negative}

Income Effect leads to positive change in rice consumption {∵price rise reduces real income & income effect is negative for inferior goods}