Question

Manuel is a bus driver who enjoys donuts and muffins. Suppose that the price of donuts increases. As a result, the purchasing power of Manuel's paycheck is diminished. Therefore, he reduces his consumption of all goods, including donuts. This phenomenon is known as the effect.

Answer 1

Answer: Income effect

Explanation: The Income effect could simply be explained as the impact of price on an individual's income which ultimately affects the demand for certain products. Using the scenario above as a case study,Assuming Manuel's income remains constant, the increase in price of Manuel's favorite, donut increases, this increase in price will lead to a decrease in Manuel's purchasing power as Manuel's income tends to suffer or diminish more due to the price increase. Therefore, in other to contain this effect, Manuel will have reduce his consumption, hence leading to lower demand for goods including that of donut.