Question

Ned buys wine and bread. When the price of wine rises the substitution effect induce Ned to buy _____ wine and _____ bread.

1. more; more.

2. more; less.

3. less; more

4. less; less.

Short answer

The correct option is c) less; more.

Step-by-step solution

Defining the substitution effect

The substitution effect talks about how the quantity demand for goods changes after a change in the price of one of the goods. The consumer always prefers or selects the cheaper commodity. Thus, a fall in the price of one good will increase the demand for the other good and vice versa.

For example, if the price of goat meat increases, the consumer will start consuming more chicken since both are substitutes and can be replaced by each other.

Explanation for the correct option (c)

The bread and wine are both everyday goods, so if the price of wine increases, it would alter the consumption of wine and bread as the income level is fixed. With an increase in the price of wine, Ned will shift the consumption towards bread. He will find bread cheaper even though the bread’s price is the same. A rational consumer will never buy more of any product when the price increases, and less of any product whose price is not increasing.

Thus, Ned will consume less wine and more bread.