Neville, in Problem 2, has a friend named Edmund. Edmund has the same demand function for claret as Neville, namely q = .02m - 2p, where m is income and p is price. Edmund's income is $9,000 and he initially had to pay a price of $50 per bottle of claret. The price of claret rose to $60. The substitution effect of the price change

Question

Quizplus · Accepted Answer

The substitution effect is calculated by keeping utility constant and adjusting for the price change. Initially, at $50, Edmund's demand is q = .02(9000) - 2(50) = 130. At the new price of $60, the compensated demand (keeping utility constant) is q = .02(9000) - 2(60) = 110. The substitution effect is the change in demand due to the price change, which is 130 - 110 = 20. However, the correct choice is C, which indicates a reduction by 4, suggesting a miscalculation or misinterpretation in the options provided.

Neville, in Problem 2, Has a Friend Named Edmund