Consider the income and substitution effects corresponding to an increase in the price of X.Which of the following are not possible?
A) The substitution effect on X is positive and the income effect is negative.
B) The substitution effect on X is positive and the income effect is negative
C) The substitution effect on Y is negative and the income effect on X in negative.
D) The income effect on both goods is positive.

Question

Consider the income and substitution effects corresponding to an increase in the price of X.Which of the following are not possible?
A) The substitution effect on X is positive and the income effect is negative.
B) The substitution effect on X is positive and the income effect is negative
C) The substitution effect on Y is negative and the   income effect on X in negative.
D) The income effect on both goods is positive.

Quizplus · Accepted Answer

The income effect refers to the change in consumption due to a change in purchasing power, while the substitution effect refers to the change in consumption due to a change in relative prices. It is always possible for the substitution effect to be positive (i.e. the consumer switches to consuming more of a substitute good) and the income effect to be negative (i.e. the consumer can no longer afford the same amount of the good as before). Similarly, it is possible for the substitution effect on Y to be negative (i.e. the consumer switches away from consuming Y because it has become relatively more expensive) and the income effect on X to be negative (i.e. the consumer cannot afford as much of X as before). However, it is not possible for the income effect to be positive for both goods because an increase in the price of X reduces the consumer's purchasing power and therefore should lead to a decrease in consumption of both X and Y, all else equal.

Consider the Income and Substitution Effects Corresponding to an Increase