Figure 10-4 -Refer to Figure 10-4.Which of the following is true at W₀? A) The income effect is larger than the substitution effect. B) The substitution effect is larger than the income effect. C) The income effect and the substitution effect are equal. D) The supply curve is positively sloped.

Question

Quizplus · Accepted Answer

At W₀, the quantity of the good demanded has increased from Q1 to Q2, and the price has increased from P1 to P2. This means that the consumer faces a higher price for the good, and so will substitute away from it to other goods that are relatively cheaper. This is the substitution effect. However, the consumer's real purchasing power has also decreased due to the price increase, which will cause the consumer to buy less of all goods, including the one in question. This is the income effect. Because the quantity demanded has increased from Q1 to Q2, we know that the substitution effect must be larger than the income effect. Therefore, the answer is B. The graph does not give us any information about the slope of the supply curve, so D is not a valid choice.

Figure 10-4 -Refer to Figure 10-4.Which of the Following Is True at Is