The substitution effect argues that a consumer
A) will always use the additional purchasing power from a price decrease to purchase more of both goods.
B) will not purchase more of a good when its price falls.
C) will purchase more of a good that has become relatively cheaper, and less of a good that has become relatively more expensive.
D) will purchase less of both goods if his or her real income increases.

Question

Quizplus · Accepted Answer

The substitution effect occurs when a consumer switches from one good to another due to a change in their relative prices. The consumer will purchase more of the good that has become relatively cheaper and less of the good that has become relatively more expensive. This is based on the idea that consumers are rational and will choose the most cost-effective option. Option A is incorrect because it assumes that the consumer will increase consumption of both goods, which is not always the case. Option B is incorrect because it fails to account for changes in relative prices. Option D is incorrect because an increase in real income would lead to an overall increase in purchasing power and is not directly related to the substitution effect.

The Substitution Effect Argues That a Consumer