Question

Emily is a rational consumer who gets utility from socks and music lessons, and she considers both of these goods normal goods. Her marginal utility from socks is 50 utils and the price of socks is $5 per pair. Her marginal utility from music lessons is 600 utils and the price of music lessons is $60.

If the price of music lessons falls to $20, which of the following best describes the income and substitution effects?
A. The income effect is that she got a raise from her employer. The substiution effect is that music lessons are now relatively cheaper so she will buy more music lessons.
B. The income effect is that she effectively has more money to spend on either good. The substitition effect is that she will only buy socks now.
C. The income effect is that she now can spend more on both goods. The substitution effect is that the price of music lessons relative to socks has decreased so she will definitely buy more music lessons.
D. The income effect is that she will no longer buy socks because she has more income to spend on music lessons, so she will only buy music lessons.
E. The substitution effect is that she now can spend more on either good. The income effect is that the price of music lessons relative to socks has decreased so she will definitely buy more music lessons.

Answer 1

The correct statement is option C, where the income effect allows Emily to spend more on both goods, and the substitution effect means she is likely to purchase more music lessons since their price has decreased relative to socks.

Step-by-step explanation:

When the price of music lessons falls for Emily, a rational consumer who views both socks and music lessons as normal goods, there are both income and substitution effects at play.

The income effect is that she effectively has more money to spend on both socks and music lessons, not that she got a raise from her employer.

The substitution effect is that music lessons are now comparatively cheaper compared to socks, so she will likely purchase more music lessons, not that she will only buy socks.

Therefore, the statement that best describes the income and substitution effects of the price change in music lessons is:

C. The income effect is that she now can spend more on both goods. The substitution effect is that the price of music lessons relative to socks has decreased, so she will definitely buy more music lessons.