Assume that peanut butter is an inferior good.Which of the following best describes the income and substitution effects as the price of peanut butter rises?

Question

Quizplus · Accepted Answer

Since peanut butter is an inferior good, as its price increases, consumers will switch to alternative goods. The substitution effect will lead consumers to buy less peanut butter and purchase more of the alternative goods. However, the income effect will work in the opposite direction, where as the price of peanut butter increases, the purchasing power of consumers decreases. Therefore, consumers will buy less of all goods, including peanut butter. However, the substitution effect dominates in this case, so the overall effect is that the consumer will buy less peanut butter but more of the substitute goods.

Assume That Peanut Butter Is an Inferior Good