anagers are very interested in how a consumer makes a choice among alternatives.
ID: 1242727 • Letter: A
Question
anagers are very interested in how a consumer makes a choice among alternatives. In this exercise, we ask you to consider the amount of money you spend purchasing gasoline to operate your automobile for a month and any alternatives available to you assuming your net income available to make those purchases. Also assume gasoline prices for your auto rose 100% during one difficult summer as our time period for the purpose of discussion. Explain, then, the following effects in terms of the income effect, or the substitution effect, or both effects:Explanation / Answer
Managers are very interested in how a consumer makes choice among alternatives. In this exercise, we ask you to 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. Also assume gasoline prices for your auto rose 100% during one difficult summer as our time period for the purpose of discussion. Explain, then, 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. The income effect is defined as what happens to your purchases as your level of real income changes. In this example, your income has not changed, but your costs have, which decrease your purchasing power - hence your real income. The substitution effect is what happens when prices change in relative terms (one thing gets more expensive and/or another gets more expensive). Note, all goods may have gone up in price due to the cost of fuel for suppliers and/or transportation for you to purchase the good but I took that into account based on the plausibility that it's underlining in the premise of the question (e.g. virtually negligible in C, but cost of gas is still important to answer the question as the health of your vehicle isn't as valuable anymore) A. Income effect - you have less money to do these things, no substitution has occurred. B. Income effect (definite) and substitution (plausible, not definite) - the relative price between cooking your own food and eating out may have changed since eating out you have to add a higher % of the cost of a meal to gas. C. income effect - you have less money to maintain your vehicle and the overall cost incurred from keeping your vehicle maintained has increased. D. substitution effect and income effect - public transportation is seen as an inferior good (as real income rises, its use decreases). Any decrease in income will produce more consumption of an inferior good. Also the relative cost has changed between two substitutible products therefore this is also a substitution effect. E. Substitution effect and income effect Same as D F. Substitution effect and income effect: poorly defined...did you take a vacation at home? Is away mean far away or even a few miles away? or just forego vacation altogether. I'll answer both ways; Vacation is a luxury good that will decrease as income goes down. Additionally, you may have substituted a cheaper vacation that isn't away from home (or as far away from home) or substituted working more which is not really consumption but in the realm of trade-offs/opportunity cost models. I'd prefer this question read as: You took your vacation at home instead of going away....or something along those lines. g. income effect; while this question doesn't define what you made due with more and if it included goods/services that had nothing to do with clothes this is my best answer (note: Original I wrote subsitution effect here too, however upon re-reading I believe in the question we are not purchasing different goods): Your real income has gone down, you can't afford as many new clothes, which is also why you are spending more time around the home. Making due with more around the home nearly implies making your own goods, if it does then the substitution effect is definitely at play here, but I wouldn't assume that in my answer.
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