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    income effect or the substitution effect

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    Managers are very interested in how a consumer makes choice among alternatives.
    Consider the price of gasoline you may purchase to operate your automobile in any month and any alternatives available to you assuming your net income available to make those purchases.
    Assume gasoline prices for your auto rose 100% during one difficult summer as our time period for the purpose of discussion.
    Explain, the following effects in terms of the income effect, or the substitution effect, or both effects:

    a.You drove less and purchased less gasoline.

    b.You ate out less often.

    c.You spent less to maintain your automobile.

    d.You took public transportation more often.

    e.You bought a bicycle.

    f.You did not take a vacation away from home.

    g.You bought fewer cloths and made due with more around the home.

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    Solution Preview

    Dear Student,

    Thank you for using BM.
    Below are my answers.


    a.You drove less and purchased less gasoline.
    Since the price of gasoline increased, then my real income also decreased. Driving less and purchasing less gasoline is an income effect as my preferences as to driving have to be adjusted due to the decrease in my real income.

    b.You ate out less ...

    Solution Summary

    The income effect and the substitution effect are considered.