Answer to Question #273322 in Microeconomics for Madu

Question

“Substitution effect of any commodity is positive for a given a price change”. Explain the validity of this statement using appropriate illustrations

Answer 1

Solution:

The statement is not valid.

This is because the substitution effect is always non-positive, that is it can either be negative or zero.

A fall in the relative price of a good always leads to an increase in the quantity demanded of the good. In other words, the substitution effect always induces the consumer to buy more of the cheaper good. When the relative price of a good increase, consumers substitute away from that good until they reach a new optimal trade-off.