18. Consumer Choice and Behavioral Economics
Consumer Optimum Consumption: Budget Constraint and Indifference Curves
Multiple Choice
A meal-plan student receives an unexpected \$200 campus credit. If ramen noodles are an inferior good for this student, how should the income effect change ramen purchases relative to the substitution effect from higher effective income?
A
The income effect reduces ramen purchases but is exactly offset by the substitution effect, leaving ramen consumption unchanged.
B
The income effect increases ramen purchases while the substitution effect decreases them; the two effects partially offset each other.
C
Both the income effect and the substitution effect reduce ramen purchases; the income effect reinforces the substitution effect, leading to a larger decrease in ramen consumption.
D
There is no income effect on ramen purchases; only the substitution effect reduces ramen consumption.
Verified step by step guidance1
Step 1: Understand the concepts of substitution effect and income effect. The substitution effect occurs when a change in the price of a good (or effective income) causes consumers to substitute one good for another, holding utility constant. The income effect occurs when a change in purchasing power (income) affects the quantity demanded of a good.
Step 2: Recognize that the student receives an unexpected \$200 campus credit, which effectively increases their income. This means the student can afford more goods overall, including ramen noodles and other foods.
Step 3: Recall that ramen noodles are described as an inferior good for this student. An inferior good is one where demand decreases as income increases, because the consumer shifts to higher-quality substitutes when they have more income.
Step 4: Analyze the substitution effect: since the effective price of other foods relative to ramen changes (due to increased income), the substitution effect will lead the student to buy less ramen and more of other goods, reducing ramen consumption.
Step 5: Analyze the income effect: because ramen is an inferior good, the increase in income causes the student to buy less ramen. Therefore, the income effect also reduces ramen purchases, reinforcing the substitution effect and leading to a larger overall decrease in ramen consumption.
