1) Rosa has a so-called fruit budget, which she uses to buy only peaches and avo
ID: 1107467 • Letter: 1
Question
1) Rosa has a so-called fruit budget, which she uses to buy only peaches and avocados. Assume the price of peaches increases. Which of the following is an example of the substitution effect?
a- The increase in the price of peaches decreases Rosa's real income, which forces Rosa to buy fewer fruits in general.
b- Because the price of peaches increases, peaches become more desirable to Rosa, who will therefore buy fewer avocados and more peaches.
c- The increase in the price of peaches makes peaches relatively more expensive than avocados, so Rosa will buy fewer peaches and more avocados.
Explanation / Answer
The substitution effect is the effect on demand of a good after taking into account the change in real income/utility/desirability. Thus option a and b are not example of substitution effect. The correct answer is option c, The increase in the price of peaches makes peaches relatively more expensive than avocados, so Rosa will buy fewer peaches and more avocados.
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