Question

An increase in the price of a good creates an incentive for consumers to shift their purchases away from the good to other goods whose prices are relatively lower. Such an effect of a price change is referred to as the:

1) Substitution effect
2) Income effect
3) Price effect
4) Demand effect

Answer 1

The term for consumers shifting their purchases from a more expensive good to cheaper alternatives is known as the substitution effect. It is linked with the income effect, which relates to changes in purchasing power due to price variations, although actual income remains unchanged.

Step-by-step explanation:

An increase in the price of a good creates an incentive for consumers to shift their purchases to relatively cheaper alternatives. This behavior is known as the substitution effect. When, for example, oranges become more expensive, consumers might buy more apples, grapefruit, or raisins instead. The income effect meanwhile, refers to a change in the purchasing power of a consumer's income due to a price change of a good, but does not imply a change in the actual income. Both the substitution effect and income effect influence consumer behavior simultaneously when there is a change in the price of goods.