Question

Suppose that a household experiences a fall in food prices and a rise in clothing prices such that its purchasing power is unchanged. Then the household will experience a ________ in clothing consumption and ________ in welfare.

Answer 1

A household may decrease clothing consumption with no change in welfare if food prices fall and clothing prices rise without affecting purchasing power, due to the income and substitution effects.

Step-by-step explanation:

If a household experiences a fall in food prices and a rise in clothing prices such that its purchasing power is unchanged, it will likely experience a decrease in clothing consumption and no change in welfare. This happens because, while the household can now buy more food due to lower prices, they must spend more on clothing because the cost has increased. The impact on overall welfare would generally remain unchanged assuming the household can make substitutions between food and clothing while maintaining the same level of satisfaction. Additionally, the income and substitution effects must be considered, where the income effect signifies how consumption varies with changes in purchasing power and the substitution effect illustrates changes in consumption patterns in response to relative price changes.