The method for finding the substitution effect of a price change on consumption of good x is to:
A)Find the initial optimal consumption basket before the price change and then find the decomposition basket and measure the change in consumption of the good between the two baskets.
B)Find the initial optimal consumption basket before the price change, then find the final optimal consumption basket after the price change and measure the change in consumption of the good between the two baskets.
C)Find the final optimal consumption basket after the price change and then find the decomposition basket and measure the change in consumption of the good between the two baskets.
D)Find the initial and final optimal consumption baskets, before and after the price change, find the decomposition basket, and add up the total changes between the two optimal baskets and the decomposition basket.

Question

Quizplus · Accepted Answer

The substitution effect is isolated by comparing the initial optimal consumption basket to a hypothetical "decomposition" or "compensated" basket that adjusts the consumer's income to keep utility constant after a price change, thus focusing solely on the substitution away from the good that has become relatively more expensive.

The Method for Finding the Substitution Effect of a Price