John Smedley, a careful maximizer of utility, consumes only two goods, peanut butter and ice cream.He had just achieved the utility-maximizing solution in his consumption of the two goods when the price of ice cream fell.As he adjusts to this event, he will consume:
A) more peanut butter and more ice cream.
B) less peanut butter and less ice cream.
C) more peanut butter and less ice cream.
D) less peanut butter and more ice cream.

Question

Quizplus · Accepted Answer

When the price of ice cream falls, John, aiming to maximize his utility, will consume more ice cream because it has become cheaper relative to peanut butter. This is known as the substitution effect. Additionally, because he spends less on the same quantity of ice cream, he has more money available, which could increase his overall consumption (income effect). However, without specific information about his income elasticity for both goods, the primary effect is the substitution towards more ice cream and potentially less peanut butter if his budget reallocates towards consuming more of the now cheaper ice cream.

John Smedley, a Careful Maximizer of Utility, Consumes Only Two