Neville from your workbook has a friend named Cedric. Cedric has the same demand function for claret as Neville, namely q = .02m - 2p, where m is income and p is price. Cedric's income is $6,000 and he initially had to pay a price of $40 per bottle of claret. The price of claret rose to $60. The substitution effect of the price change

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Quizplus · Accepted Answer

The substitution effect is calculated by keeping utility constant and only considering the change in price. Initially, Cedric's demand is q = 0.02(6000) - 2(40) = 40. After the price increase, the demand at the new price is q = 0.02(6000) - 2(60) = 20. The substitution effect is the change in demand due to the price change alone, which is 40 - 20 = 20. However, the correct calculation for the substitution effect involves finding the hypothetical demand if the price change occurred but income was adjusted to keep utility constant. This typically requires more information or assumptions about utility, but given the options, the closest choice is A, which suggests a reduction by 24.

Neville from Your Workbook Has a Friend Named Cedric