Suppose Lisa spends all of her money on books and coffee.When the price of coffee decreases,the
A) substitution effect on coffee is positive, and the income effect on coffee is positive.
B) substitution effect on coffee is ambiguous, and the income effect on coffee is ambiguous.
C) substitution effect on coffee is positive, and the income effect on coffee is ambiguous.
D) substitution effect on coffee is ambiguous, and the income effect on coffee is positive.

Question

Quizplus · Accepted Answer

Since Lisa spends all of her money on books and coffee, when the price of coffee decreases, she will have extra income to spend on either books or coffee. This is the income effect, and its direction is ambiguous. However, since coffee is now relatively cheaper compared to books, Lisa may substitute some of her book purchases with additional coffee purchases. This is the substitution effect, and it will be positive as coffee became relatively cheaper. Therefore, the best answer is (C).

Suppose Lisa Spends All of Her Money on Books and Coffee.When