Neville, has a friend named Algernon.Algernon has the same demand function for claret as Neville, namely q = .02m - 2p, where m is income and p is price.Algernon's income is $5,500 and he initially had to pay a price of $20 per bottle of claret.The price of claret rose to $50.The substitution effect of the price change
A)reduced his demand by 60.
B)reduced his demand by 18.
C)reduced his demand by 102.
D)increased his demand by 60.
E)reduced his demand by 28.

Question

Quizplus · Accepted Answer

To calculate the substitution effect, we hold the consumer's utility constant before and after the price change by adjusting their quantity demanded. We can find Algernon's initial quantity demanded using his demand function:

q = 0.02(5500) - 2(20) = 430

After the price change, Algernon faces a price of $50. We can use his demand function again to find his new quantity demanded:

q' = 0.02(5500) - 2(50) = 340

The substitution effect is the reduction in quantity demanded due to the price change, which is:

SE = q - q' = 430 - 340 = 90

Therefore, Algernon's demand is reduced by 90, which is equivalent to Choice B.

Neville, Has a Friend Named Algernon