Assume convex preferences and a negative cross price elasticity. If the price of good 1 increases, the substitution effect causes
A)consumption of good 1 to rise and good 1 to fall
B)consumption of good 2 to rise and good 1 to fall
C)consumption of good 2 to fall and good 1 to fall
D)consumption of good 1 to fall and good 2 to remain unchanged

Question

Quizplus · Accepted Answer

The substitution effect, given a negative cross price elasticity, implies that as the price of good 1 increases, consumers will substitute away from good 1 towards good 2, leading to a rise in the consumption of good 2 and a fall in the consumption of good 1.

Assume Convex Preferences and a Negative Cross Price Elasticity