Question

For inferior goods, the substitution effect of a price decrease and the income effect of the same price decrease:

• A. Work in opposite direction
• B. Work in the same direction and decrease the aggregate consumption of the good
• C. Work in opposite direction and decrease aggregate consumption of the good
• D. Work in the same direction

Hint:

Know how substitution and income effects differ for inferior goods.

Answer 1

The Correct Option is A

For inferior goods, the substitution effect and the income effect work in opposite directions. A decrease in the price of the good makes it more attractive relative to other goods (substitution effect), leading to increased consumption. However, the income effect for inferior goods leads to a decrease in consumption because as income increases (due to lower prices), consumers prefer to buy less of the inferior good. Hence, the substitution effect and income effect work in opposite directions. Thus, the correct answer is (a).