What is the benefit of understanding the income and the substitution effects?
A) The income effect might run in the opposite direction of the substitution effect.
B) The income effect always runs in the opposite direction of the substitution effect.
C) The income and substitution effects just offset each other, which explains a lot.
D) The income and substitution effects are proportional to each other.

Question

Quizplus · Accepted Answer

Understanding the income and substitution effects allows for an analysis of how changes in price and income affect demand for a good. It's important to consider both effects as they may either complement or counteract each other, leading to an overall change in demand that may not be immediately clear without examining both effects. It's not true that the income effect always runs in the opposite direction of the substitution effect, so option B is incorrect. Option C is also incorrect because both effects do not necessarily always offset each other. Option D is incorrect because the income and substitution effects are not proportional to each other.

What Is the Benefit of Understanding the Income and the Substitution