Question

Tammy spends her money on lemonade and iced tea. If the price of lemonade falls, it is as though her income _______.

1) increases
2) decreases
3) stays the same
4) cannot be determined

Answer 1

When the price of lemonade falls, it is analogous to an increase in Tammy's income because she can get more for the same amount of money, presuming lemonade is a normal good and other factors remain constant. So the correct answer is option 1.

Step-by-step explanation:

If the price of lemonade falls, it is as though Tammy's income increases, because she can now buy the same amount of lemonade for less money, or more lemonade for the same amount of money, which is similar to having more purchasing power or effectively a higher income.

This concept ties into the ceteris paribus assumption used in economics, which means 'all other things being equal'. In this context, with the fall in the price of lemonade and Tammy's income and the price of iced tea remaining the same, Tammy experiences an increase in her real income with respect to her ability to purchase lemonade.

This situation often leads to the consumer purchasing more of the good that has become cheaper, which is a typical reaction if we consider lemonade as a normal good.