Question

Match the pairs with answers.

Answer 1

The rising price of gold causes people to buy silver jewelry instead.
substitution effect

When the price of chicken increases, families reduce their chicken intake substantially.
income effect

A new factory in a village provides livelihoods for the villagers.
positive externiality

A new factory in a village causes noise pollution.
negative externiality

Answer 2

Let's match each term with its definition

• positive externality : A new factory in a village provides livelihoods
• for the villagers.  An externality is an unintended consequence generated by an economic activity on external parties, not directly involved at first in the production process or in the transactions derived from it. In this case, the externality is positive because the establishment of the factory brings economic development to the town.
• negative externality: A new factory in a village causes noise pollution. The pollution generated by the factory is a negative unintended consequence generated by the production process and hence, a negative externality.

• substitution effect : The rising price of gold causes people to buy silver jewelry instead. When there is a price increase, according to the law of demand, the quantity desired by consumers decreases. The subsistution effect represents the part of that consumption reduction generated by the variation in relative prices, in this case, the variation of the price of gold if compared to substitute products. Therefore, after the price increase, consumers would turn to consume more of the relatively cheaper substitutes (silver jewelery).
• income effect: When the price of chicken increases, families reduce their chicken intake substantially. When there is a price increase, according to the law of demand, the quantity desired by consumers decreases. The income effect represents the part of that consumption reduction generated by the decrease in real income available, as with the same amount of income now families can consume a fewer amount of (more expensive!) products than before. Therefore, in the example provided, families decrease their chicken purchases.