📚 Learning Guide
Utility Maximization After Price Change
hard

How does the substitution effect influence consumer surplus when the price of a good decreases, and how is this represented in terms of indifference curves?

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Choose the Best Answer

A

Consumer surplus increases due to the substitution effect, shifting the budget line outward.

B

Consumer surplus decreases as the indifference curve shifts downwards.

C

The substitution effect has no impact on consumer surplus when the price changes.

D

Consumer surplus increases when the indifference curve intersects the original budget line.

Understanding the Answer

Let's break down why this is correct

Answer

When the price of a good decreases, consumers often feel that they can buy more of that good without spending more money, which is known as the substitution effect. This means that they may choose to buy more of the cheaper good instead of a more expensive one. As a result, consumer surplus, or the extra benefit consumers get from paying less than what they are willing to pay, increases. In terms of indifference curves, this change can be shown by a movement to a higher indifference curve, indicating that consumers can achieve a higher level of satisfaction with their new choices. For example, if the price of apples drops, a consumer might buy more apples, leading to greater satisfaction and a larger consumer surplus than before.

Detailed Explanation

When the price of a good goes down, people can buy more of it. Other options are incorrect because This answer suggests that happiness decreases when the price drops, which is not true; This option says the substitution effect does nothing, but it actually helps people buy more.

Key Concepts

substitution effect
indifference curves
consumer surplus
Topic

Utility Maximization After Price Change

Difficulty

hard level question

Cognitive Level

understand

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