There are many different factors that impact the price elasticity of demand. More specifically, the proportion of budget and the income effect refer to how price as a portion of income influences price elasticity. Which of the following is true

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The question asks about how the income effect and the proportion of budget relate to price elasticity of demand when price changes.
Option 1: 'Income effect says higher relative price increases elasticity; proportion of budget says higher relative price decreases elasticity' This says the income effect would make elasticity rise with a higher price, but then claims the budget share would cause elasticity to fall as price rises. The two effects are typically aligned in suggesting that a larger price relative to income (either via income effect or budget share) tends to make demand more elastic, not less, so mixing one increasing and the other decreasing is inconsistent with standard intuition.
Option 2: 'Both say higher relative price increases elasticity' Here, both the income effect and the proportion of budget are commonly viewed as making elasticity larger when the price becomes a bigger share of income. When a price hike consumes a larger portion of income, consumers feel the hit more and adjust quantity more; similarly, goods that take up a larger budget share tend to have more elastic responses because small price changes lead to larger proportional budget effects and clearer substitution possibilities. This option matches the typical interpretation that higher relative price amplifies responsiveness in both channels.
Option 3: 'Income effect says higher relative price decreases elasticity; proportion of budget says higher relative price increases elasticity' This splits the direction of the income effect, asserting that income effect would dampen responsiveness as price rises, which goes against the common view that a larger income effect (from a price increase that reduces real income) tends to heighten sensitivity to price or at least reflect a stronger overall reaction. The mismatch makes this option inconsistent.
Option 4: 'Both say higher relative price decreases elasticity' This would imply that as price becomes a larger portion of income, demand becomes less responsive, which contradicts the intuitive and standard notion that higher price burdens lead to stronger quantity adjustments and higher elasticity, particularly through the budget share channel and the income effect.
In summary, the reasoning for each choice hinges on whether a larger price relative to income makes demand more or less responsive. The prevailing interpretation is that both the income effect and the budget proportion contribute to greater elasticity when price is a larger share of income, making Option 2 the coherent choice among the four presented.

COMM_V 296 103 104 2025W1 2025W1 COMM 296 Final Exam - December 15- Requires Respondus LockDown Browser

There are many different factors that impact the price elasticity of demand. More specifically, the proportion of budget and the income effect refer to how price as a portion of income influences price elasticity. Which of the following is true

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