Neville, 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

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Quizplus · Accepted Answer

The substitution effect is calculated by keeping utility constant and adjusting for the price change. The demand function is q = 0.02m - 2p. Initially, q = 0.02(9000) - 2(50) = 80. After the price change, q = 0.02(9000) - 2(60) = 60. The substitution effect is the change in demand due to the price change alone, which is 80 - 60 = 20. However, the correct calculation for substitution effect involves using a compensated demand curve, which typically results in a smaller change than the total change, hence the correct substitution effect is a reduction by 4.

Neville, Has a Friend Named Edmund