Question

According to the income effect, when the price of a good increases, the consumer’s spending power _____________. As spending power decreases, ________ of a normal good will be demanded.

a.	increases; more	b.	increases; less
c.	decreases; less	d.	decreases; more

The income effect implies that as the price of a good increases, your ________ income will ________.

a.	nominal; increase	b.	nominal; decrease
c.	real; decrease.	d.	real; increase

There is an increase in the price of pretzels (a normal good). We would predict the substitution effect would encourage __________ in quantity demanded and the income effect would encourage __________ in quantity demanded.

a.	an increase; an increase	b.	an increase; a decrease
c.	a decrease; a decrease	d.	a decrease; an increase

A seller will accept as little as $10 for an item, but negotiates a price of $15 from a buyer who would, in fact, be willing to pay $35. What is the consumer surplus?

a.	$10	b.	$15
c.	$25	d.	$20

Answer 1

Q1 Answer is D. Decreases; less.

When price increases real income of consumer decreases and consumer will decrease the demand for the good.

Q2 Answer is C. real; decreases.

As the price increases real income of consumer will decrease.

Q3 Answer is C. Decrease ; Decrease.

Increase in price will decrease the demand of the good because consumer will prefer to purchase substitute good. So it is substitution effect . Increase in price will decrease the real income of consumer which will decrease the demand of the good which is income effect.

Q4 answer is D. $20

Consumer surplus is the difference between what consumer is wiiling to pay and what consumer actually paid. Here consumer was willing to pay $35 but he actually paid only $15 , So consumer surplus is 35 - 20 = $20.

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