What do the income and substitution effects provide an explanation for?
A) why the supply curve is vertical
B) why the supply curve is horizontal
C) why the demand curve is upward sloping
D) why the demand curve is downward sloping

Question

Quizplus · Accepted Answer

The income and substitution effects provide an explanation for why the demand curve is downward sloping. The income effect refers to the change in quantity demanded due to a change in real income (purchasing power) caused by a change in price. When the price of a good decreases, consumers' real income increases, allowing them to purchase more of the good. The substitution effect refers to the change in quantity demanded due to a change in relative prices between two goods. When the price of a good decreases relative to another substitute good, consumers will switch their purchases to the cheaper good, resulting in an increase in quantity demanded. These two effects together explain why as the price of a good decreases, consumers will demand more of it.

What Do the Income and Substitution Effects Provide an Explanation