Sarah usually buys 5 cups of coffee and 2 muffins every day. The price of coffee falls significantly. Explain how the substitution effect and the income effect influence Sarah’s decision to buy more coffee.

Question

BlackTom AI · Accepted Answer

Here is a careful walk-through of each answer choice, focusing on substitution and income effects in the context of Sarah's coffee purchases.
Option 1: Substitution effect: Coffee becomes relatively cheaper, so Sarah buys more; Income effect: Lower coffee prices make Sarah feel richer, so she may buy more of all goods. This aligns with standard consumer theory. The substitution effect occurs when the relative price of coffee falls, encouraging the consumer to substitute coffee for muffins or other goods, increasing coffee quantity demanded. The income effect arises because a lower price effectively raises real purchasing power; as a result, Sarah may buy more of both coffee and muffins, assuming normal goods. Overall, this option correctly describes both effects and their impact on the decision to buy more coffee.
Option 2: Substitution effect: Coffee becomes more expensive, so Sarah buys less; Income effect: Lower coffee prices make Sarah feel poorer, so she buys less of all goods. This reverses the actual mechanism. A fall in price makes coffee relatively cheaper, not more expensive, so the substitution effect would push toward more coffee, not less. The income effect would make Sarah feel richer, not poorer, when prices fall, not the other way around. Therefore, this option misstates both the direction of the substitution effect and the sign of the income effect.
Option 3: Substitution effect: Coffee price doesn’t matter; Income effect: Sarah buys more coffee because she likes it. The substitution effect is precisely about changes in relative prices influencing choices; claiming the substitution effect doesn’t matter ignores a core driver of consumer behavior when prices change. Also, while she may like coffee, the question is about responses to a price drop; this option fails to integrate how the change in relative price would shift demand, making it incomplete and incorrect.
Option 4: Substitution effect: Sarah buys fewer muffins; Income effect: She buys fewer muffins. This option focuses only on muffins and asserts a decrease in muffin purchases, but it does not address Coffee’s price change or the standard expectations from substitution and income effects on coffee demand. If coffee becomes cheaper, substitution would typically increase coffee demand and could reduce muffins if budget is reallocated; however, the claim that both effects lead to fewer muffins is overly narrow and unsupported as a general rule. This makes the statement misleading as a description of the full effect on Sarah’s overall consumption pattern.

ECON 2002.01 AU2025 (21333) Midterm Exam 1- Requires Respondus LockDown Browser

Sarah usually buys 5 cups of coffee and 2 muffins every day. The price of coffee falls significantly. Explain how the substitution effect and the income effect influence Sarah’s decision to buy more coffee.

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ECON 2002.01 AU2025 (21333) Midterm Exam 1- Requires Respondus LockDown Browser

Sarah usually buys 5 cups of coffee and 2 muffins every day. The price of coffee falls significantly. Explain how the substitution effect and the income effect influence Sarah’s decision to buy more coffee.

View Explanation

Log in for full answers

Similar Questions

For Sarah, meals at McDonald’s are an inferior good. When the price of meals at McDonald’s increases, Sarah buys less McDonald’s meals. This means that:

If a good is normal and its price increases,

Which of the following occurs simultaneously with an income effect?

Rose is allocating her budget between two goods—Apples and Bananas; both are normal goods. If the price of apples increases from $1 per pound to $2 per pound, then the income effect causes her to buy ___of apples and the substitution effect causes her to buy___ of apples.

The effect of a change in relative price on consumer choice can be divided into:

Which of the following occurs simultaneously with an income effect?

Assume that a consumer has well-behaved preferences. Following a price increase for good 1, we observe that a consumer increases the quantity demanded for good 1. From this, we know that

Consider a consumer buying perfect complements. If there is a decrease in the price of good 1, the total change in consumption of good 1 is due to

More Practical Tools for Students Powered by AI Study Helper

Making Your Study Simpler

Rose is allocating her budget between two goods—Apples and Bananas; both are normal goods. If the price of apples increases from $1 per pound to $2 per pound, then the income effect causes her to buy _of apples and the substitution effect causes her to buy_ of apples.