Question

Rick purchases two goods, food and clothing. He has a diminishing marginal rate of substitution of food for clothing. Let x denote the amount of food consumed and y the amount of clothing. Suppose the price of food increases from Px1 to Px2. For which of the following cases the price effect equals the substitution effect?

A.Food is a normal good.

B.Food is neither a normal good nor an inferior good.

C.The income elasticity of demand for food is zero.

D.The income elasticity of demand for food is infinity.

E. Food is a Giffen good.

Answer 1

Ans. Option C

When price of food increases, from substitution effect, the consumption of food should decrease because now food is relatively expensive then clothing and from income effect also, the consumption of food should decrease because with increase in price of food, the real income has fallen and with decrease in income consumption of both food and clothing will fall. When price effect equals substitution effect, this means that income effect is zero i.e. decrease in real income won't change the consumption of food. Thus, income elasticity of demand for food is zero.

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