Question

Theoretically, you can isolate the substitution effect by:

Group of answer choices

Reducing people's substitution constraint.

Substituting money with consumption.

Compensating people with money as the price of a good increases.

Compensating people with money as the price of a good decreases.

Answer 1

Option c is correct. . We can isolate the substitution effect by compensating people with money as the price of good increases. Substitution effect shows the changes in purchase of commodity as a result of changes towards in relative price and real income become constant. So if price of a commodity X commodity rises, real income of consumer falls. So people will consume less quantity of good X. In order to allow the consumer to purchase same amount of commodity X , and substitution effect ( due to increase in price ) can be isolated by compensating people with money . All other options are wrong. Substitution effect can not be isolated by reducing people 's substitution constraint, substitution money with consumption, In order to isolate substitution effect when price of good decreases , we have to withdraw money from consumer