Question

Scarlett loves songs about pirates. Her parents give her money each month, and their objective is to keep her utility level roughly constant from month to month. So when the price of online pirate songs increases, her parents increase their monthly payment by an amount equal to the change in the price times the number of pirate songs Scarlett purchased before the price increase. For example, if the price increases by $0.20 and Scarlett bought 10 pirate songs per month at the previous price her parents will pay her an additional $2 per month.
How will Scarlett respond to an increase in price? She can afford the same bundle of goods as before, but will she choose it? The substitution effect tells us that Scarlett will consume fewer pirate songs even though she could afford to buy the same number. The increase in the price of songs relative to the price of other goods will cause her to substitute other goods for pirate songs.



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  • CreatedDecember 04, 2012
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