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Using the Substitution and Income Effects

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For each of the following events, consider how you might react. What things might you consume more or less of? Would you work more or less? Would you increase or decrease your saving?

a. You have a very close friend who lives in another city, a 3-hour bus ride away. The price of a round-trip ticket rises from $20 to $45.

b. You receive an award that pays you $300 per month for the next 5 years.

c. The price of food doubles.

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Solution Summary

This solution uses the Substitution Effect and Income Effect to predict a consumer's reactions to changes in his financial situation.

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a. Consistent with the substitution effect, I would visit my friend less and call him long distance ...

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