Question

Suppose that the price of a good decreased.
The substitution effect shows the change in consumption for all goods in reaction to a change in _____ holding ______constant.
The income effect shows the change in consumption for all goods in reaction to a change in _______ holding _______constant.

Answer 1

Answer:

(1) Relative prices; Utility

(2) Purchasing power; Relative prices

Explanation:

Substitution effect:

When there is a change in the quantity demanded for a good due to any change in the price level of the good is known as substitution effect. If the price of a good decreases then as a result there is a change in the consumption for all the goods due to change in the relative prices and holding the utility constant.

Income effect:

When there is a change in the quantity demanded for a good due to change in the purchasing power of the consumer because of any change in the price level and we are holding relative prices constant.