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Difficulty: MediumIncome and Substitution Effects on Demand

When the price of Good X rises, a consumer experiences a substitution effect that reduces consumption of Good X by 6 units, and an income effect that increases consumption of Good X by 2 units. Which of the following statements correctly classifies Good X and describes the overall change in its quantity demanded?

  1. Good X is an inferior good, and total quantity demanded decreases by 4 units.Answer
  2. B
    Good X is a Giffen good, and total quantity demanded increases by 4 units.
  3. C
    Good X is a normal good, and total quantity demanded decreases by 8 units.
  4. D
    Good X is an inferior good, and total quantity demanded increases by 8 units.

Answer

Good X is an inferior good, and total quantity demanded decreases by 4 units.
The correct response accurately applies the price effect identity (Total Effect = Substitution Effect + Income Effect). When the price of Good X rises, real income declines. A positive reaction in consumption (+2 units) from a fall in real income characterizes an inferior good. Combining the negative substitution effect (-6 units) and positive income effect (+2 units) yields a net reduction of 4 units in quantity demanded.

Step-by-Step Solution

1
Determine the type of good based on the income effect direction
Real income decreases when price increases. Since the income effect causes consumption of Good X to increase (+2 units) when real income drops, Good X must be an inferior good.
By definition, an inferior good has an inverse relationship between real income and quantity demanded.
2
Calculate the total price effect
Total Effect = Substitution Effect + Income Effect = -6 + 2 = -4 units.
The total change in quantity demanded is the algebraic sum of the substitution effect and the income effect.
3
Determine if the good is a Giffen good
Since the substitution effect (-6) outweighs the income effect (+2), total quantity demanded falls by 4 units. Thus, it obeys the law of demand and is not a Giffen good.
A Giffen good is a special inferior good where the income effect exceeds the substitution effect.

Key Concept

Decomposition of Price Effect into Income and Substitution Effects
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Topics

Income and Substitution Effects on Demand

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