Joe's utility function is given by U(x,y)= min[x,y] . The price of x is $4 and the price of y is $2 and Joe's income is $12. If the price of x decreases to $2 but Joe's income stays constant, then:
A)the substitution effect is zero.
B)the substitution effect exceeds the income effect.
C)the income effect is zero.
D)the total effect is zero.

Question

Quizplus · Accepted Answer

Since the price of x decreases and the income stays constant, Joe will substitute x for y to maximize his utility. However, the decrease in the price of x means that Joe can buy more of both goods while staying within his budget constraint. Therefore, the income effect and substitution effect offset each other, resulting in a zero net effect on the quantity demanded of x. Therefore, the substitution effect is zero.

Joe's Utility Function Is Given by U(x,y)= Min[x,y]