Chapter 21/The Theory of Consumer Choice ❖ 81
115. A consumer consumes two normal goods, popcorn and Pepsi. The price of Pepsi rises. The substi-
tution effect, by itself, suggests that the consumer will consume
a.
more popcorn and more Pepsi.
b.
less popcorn and less Pepsi.
c.
more popcorn and less Pepsi.
d.
less popcorn and more Pepsi.
116. Assume that a college student purchases only Ramen noodles and textbooks. If Ramen noodles are
an inferior good and textbooks are a normal good, then the substitution effect associated with a de-
crease in the price of a textbook, by itself, will result in
a.
a decrease in the consumption of textbooks and a decrease in the consumption of Ramen
noodles.
b.
a decrease in the consumption of textbooks and an increase in the consumption of Ramen
noodles.
c.
an increase in the consumption of textbooks and an increase in the consumption of Ramen
noodles.
d.
an increase in the consumption of textbooks and a decrease in the consumption of Ramen
noodles.
117. Assume that a college student purchases only Ramen noodles and textbooks. If Ramen noodles are
an inferior good and textbooks are a normal good, then the substitution effect associated with a de-
crease in the price of Ramen noodles, by itself, will result in
a.
a decrease in the consumption of textbooks and a decrease in the consumption of Ramen
noodles.
b.
a decrease in the consumption of textbooks and an increase in the consumption of Ramen
noodles.
c.
an increase in the consumption of textbooks and an increase in the consumption of Ramen
noodles.
d.
an increase in the consumption of textbooks and a decrease in the consumption of Ramen
noodles.
118. Consider a consumer who purchases two goods, X and Y. If the price of good Y falls, then the sub-
stitution effect by itself will
a.
cause the consumer to buy more of good Y and less of good X.
b.
cause the consumer to buy more of good X and less of good Y.
c.
not affect the amount of goods X and Y that the consumer buys.
d.
result in an upward-sloping demand for good Y if the substitution effect is positive.
82 ❖ Chapter 21/The Theory of Consumer Choice
119. Pepsi and pizza are normal goods. When the price of pizza falls, the substitution effect by itself will
cause a
a.
shift to a lower indifference curve so that the consumer buys less Pepsi.
b.
shift to a higher indifference curve so that the consumer buys more Pepsi.
c.
movement along the indifference curve so that the consumer buys more Pepsi.
d.
movement along the indifference curve so that the consumer buys less Pepsi.
120. Steak and pasta are normal goods. When the price of pasta falls, the substitution effect by itself
causes
a.
the consumer to feel richer, so the consumer buys more steak.
b.
the consumer to feel richer, so the consumer buys less steak.
c.
steak to be relatively more expensive, so the consumer buys less steak.
d.
steak to be relatively less expensive, so the consumer buys more steak.
121. Pepsi and pizza are normal goods. When the price of pizza rises, the substitution effect causes Pepsi
to be relatively
a.
more expensive, so the consumer buys more Pepsi.
b.
more expensive, so the consumer buys less Pepsi.
c.
less expensive, so the consumer buys more Pepsi.
d.
less expensive, so the consumer buys less Pepsi.
122. Which effect of a price change moves the consumer along the same indifference curve to a point
with a new marginal rate of substitution?
a.
the budget effect
b.
the preference effect
c.
the substitution effect
d.
the income effect
123. The substitution effect of a price change is depicted by a
a.
movement along the budget constraint holding satisfaction constant.
b.
shift in the budget constraint at the old prices.
c.
movement along the consumer’s new indifference curve at the new prices.
d.
movement along the original indifference curve to the point where the marginal rate of
substitution equals the price ratio for the new set of prices.
Chapter 21/The Theory of Consumer Choice ❖ 83
124. Which of the following descriptions best depicts the substitution effect?
a.
the change in consumption resulting from a change in the consumer’s income, holding the
prices of the goods constant
b.
the change in consumption resulting from a change in the consumer’s income, holding the
consumer’s level of satisfaction constant
c.
the change in consumption resulting from a change in the price of one good, holding the
consumer’s level of satisfaction constant
d.
the change in consumption resulting from a change in the price of one good, allowing the
consumer’s level of satisfaction to change
125. The change in consumption that results when a price change moves the consumer along a given in-
difference curve to a point illustrating the new marginal rate of substitution is called the
a.
income effect.
b.
substitution effect.
c.
Giffen good effect.
d.
inferior good effect.
126. Suppose that for Emily, DVDs and trips to the movie theater are perfect substitutes. Currently,
Emily is spending all of her income on trips to the movie theater. If the price of DVDs doubles, the
substitution effect will
a.
be two times the income effect.
b.
be half the income effect.
c.
be zero.
d.
always increase the number of trips to the movie theater Emily makes.
84 ❖ Chapter 21/The Theory of Consumer Choice
Figure 21-22
127. Refer to Figure 21-22. When the price of X is $80, the price of Y is $20, and the consumer’s in-
come is $160, the consumer’s optimal choice is D. Then the price of X decreases to $20. The sub-
stitution effect can be illustrated as the movement from
a.
D to E.
b.
D to C.
c.
C to E.
d.
E to D.
128. Refer to Figure 21-22. When the price of X is $80, the price of Y is $20, and the consumer’s in-
come is $160, the consumer’s optimal choice is D. Then the price of X decreases to $20. The in-
come effect can be illustrated as the movement from
a.
D to E.
b.
D to C.
c.
C to E.
d.
E to D.
D
C
E
IC2
IC1
1 2 3 4 5 6 7 8 9 x
1
2
3
4
5
6
7
8
y
Chapter 21/The Theory of Consumer Choice ❖ 85
129. Refer to Figure 21-22. When the price of X is $80, the price of Y is $20, and the consumer’s in-
come is $160, the consumer’s optimal choice is D. Then the price of X decreases to $20. The de-
mand curve can be illustrated as the movement from
a.
D to E.
b.
D to C.
c.
C to E.
d.
E to D.
130. A consumer consumes two normal goods, sandwiches and milk. When the price of milk is $0.50 per
glass, the consumer purchases 40 glasses. When the price rises to $0.65 per glass, the consumer
purchases 30 glasses. We can use the information provided by the consumer’s optimum choices to
derive the
a.
demand curve for milk.
b.
demand curve for sandwiches.
c.
supply curve for milk.
d.
labor-leisure tradeoff.
131. When we derive the demand curve for a good, we should remember that the
a.
income effect must be greater than the substitution effect.
b.
substitution effect must be greater than the income effect.
c.
substitution effect must be in the same direction as the income effect.
d.
income effect and the substitution effect may work in the same or in opposite directions.
132. Given a consumer’s indifference map, the demand curve for a good can
a.
be derived by moving a consumer’s budget constraint as her income falls.
b.
be derived by moving a consumer’s budget constraint as her income rises.
c.
be derived by moving a consumer’s budget constraint as the market price of one good
changes.
d.
not be derived from consumer theory.
133. An individual’s demand curve for a good is derived by varying the
a.
income level and observing the resulting total utility derived from both goods.
b.
price of one good and observing the resulting quantities of the other good.
c.
budget line to the left and calculating the loss in total utility.
d.
price of one good and observing the resulting quantities demanded of that good.
86 ❖ Chapter 21/The Theory of Consumer Choice
134. Consumer theory provides the foundation for understanding demand curves because
a.
each point on a demand curve represents an optimal choice point.
b.
consumers purchase more inferior goods than normal goods.
c.
increases in income cause the budget constraint to rotate inward along one axis, which
changes the consumer’s purchases.
d.
increases in income cause the budget constraint to rotate outward along one axis, which
changes the consumer’s purchases.
THREE APPLICATIONS
1. We can use the theory of consumer choice to analyze
a.
why most demand curves slope downward.
b.
the tradeoff between work and leisure
c.
how interest rates affect household saving.
d.
All of the above are correct.
2. If a good is a Giffen good, then
a.
the supply curve is downward sloping.
b.
the demand curve is upward sloping.
c.
the demand curve is horizontal.
d.
there is no optimal level of consumption for the consumer.
3. All Giffen goods are
a.
inferior goods, and all inferior goods are Giffen goods.
b.
inferior goods, but not all inferior goods are Giffen goods.
c.
normal goods, but not all normal goods are Giffen goods.
d.
normal goods, and all normal goods are Giffen goods.
4. A Giffen good is a good for which an increase in the price
a.
decreases the quantity supplied.
b.
increases the quantity supplied.
c.
decreases the quantity demanded.
d.
increases the quantity demanded.
Chapter 21/The Theory of Consumer Choice ❖ 87
5. A Giffen good is a good for which
a.
an increase in the price raises the quantity demanded.
b.
the income effect outweighs the substitution effect.
c.
an increase in the price decreases the quantity demanded.
d.
Both a) and b) are correct.
6. A Giffen good is a good for which
a.
a decrease in the price decreases the quantity demanded.
b.
the substitution effect outweighs the income effect.
c.
an increase in the price decreases the quantity demanded.
d.
Both a) and b) are correct.
7. A Giffen good is a good for which
a.
a decrease in the price decreases the quantity demanded.
b.
the income effect outweighs the substitution effect.
c.
an increase in the price decreases the quantity demanded.
d.
Both a) and b) are correct.
8. When a consumer experiences a price increase for an inferior good, if the income effect is
a.
greater than the substitution effect, the demand curve will be downward sloping.
b.
greater than the substitution effect, the demand curve will be upward sloping.
c.
less than the substitution effect, the demand curve will be upward sloping.
d.
less than the substitution effect but the substitution effect is positive, the demand curve
will be upward sloping.
9. When a consumer experiences a price decrease for an inferior good, if the income effect is
a.
less than the substitution effect, the demand curve will be downward sloping.
b.
greater than the substitution effect, the demand curve will be upward sloping.
c.
less than the substitution effect, the demand curve will be upward sloping.
d.
both a) and b) are correct.
10. Consider the indifference curve map and budget constraint for two goods, beef and potatoes. Sup-
pose the good measured on the horizontal axis, potatoes, is a Giffen good. Beef is measured on the
88 ❖ Chapter 21/The Theory of Consumer Choice
vertical axis and is a normal good. When the price of potatoes increases, the substitution effect
causes
a.
an increase in the consumption of potatoes, and the income effect causes a decrease in the
consumption of potatoes. The substitution effect is less than the income effect.
b.
a decrease in the consumption of potatoes, and the income effect causes an increase in the
consumption of potatoes. The substitution effect is greater than the income effect.
c.
an increase in the consumption of potatoes, and the income effect causes a decrease in the
consumption of potatoes. The substitution effect is greater than the income effect.
d.
a decrease in the consumption of potatoes, and the income effect causes an increase in the
consumption of potatoes. The substitution effect is less than the income effect.
11. A Giffen good is one in which the quantity demanded rises as the price rises because the income ef-
fect
a.
reinforces the substitution effect.
b.
reinforces and is greater than the substitution effect.
c.
counteracts but is smaller than the substitution effect.
d.
counteracts and is greater than the substitution effect.
12. Violations of the law of demand are assumed to occur
a.
regularly.
b.
only when goods are Giffen goods.
c.
only when the substitution effect dominates the income effect.
d.
All of the above are correct.
13. Giffen goods have positively-sloped demand curves because they are
a.
inferior goods with no substitution effect.
b.
normal goods with no substitution effect.
c.
inferior goods for which the substitution effect outweighs the income effect.
d.
inferior goods for which the income effect outweighs the substitution effect.
14. Giffen goods have positively-sloped demand curves because they are
a.
normal goods for which the income effect outweighs the substitution effect.
b.
normal goods for which the substitution effect outweighs the income effect.
c.
inferior goods for which the income effect outweighs the substitution effect.
d.
inferior goods for which the substitution effect outweighs the income effect.
Chapter 21/The Theory of Consumer Choice ❖ 89
15. Which of the following statements is not correct?
a.
Reducing taxes on interest income might encourage people to save more.
b.
Reducing taxes on interest income might reduce saving.
c.
A price increase will create income and substitution effects that will both always work to
reduce consumption of the good.
d.
Utility is maximized when the marginal rate of substitution between any two goods equals
the relative prices of the two goods.
16. Which of the following is an example of a Giffen good?
a.
potatoes during the Irish potato famine
b.
rice in the Chinese province of Hunan
c.
fish in Japan
d.
Both a and b are correct.
17. Which of the following is an example of a Giffen good?
a.
fish in Japan
b.
rice in the Chinese province of Hunan
c.
pork in India
d.
Both a and b are correct.
18. Pete consumes two goods, rice and fish. When the price of fish rises, he consumes less fish. When
the price of rice rises, he consumes more rice. For Pete,
a.
fish is not a Giffen good but rice is.
b.
rice is not a Giffen good but fish is.
c.
both fish and rice are normal goods.
d.
both fish and rice are Giffen goods.
19. Two economists found empirical evidence that when the price of rice decreased in the Hunan prov-
ince of China, local residents consumed less rice than before the price decrease. The study provides
a real-world example of a(n)
a.
normal good.
b.
inferior good that is not a Giffen good.
c.
Giffen good.
d.
luxury good.
90 ❖ Chapter 21/The Theory of Consumer Choice
Scenario 21-2
Fred has recently graduated from college with a degree in journalism and economics. He has
decided to pursue a career as a freelance journalist writing for business newspapers and magazines.
Fred is typically awake for 112 hours each week (he sleeps an average of 8 hours each day). For
each hour Fred spends writing, he can earn $75. Fred is such a good writer that he can get paid for
as many hours of writing as he chooses to work.
20. Refer to Scenario 21-2. If Fred decides to spend 80 hours a week playing volleyball on the beach
and the rest of his time writing, how much income will he have available to spend on consumption
goods?
a.
$900
b.
$1,500
c.
$2,400
d.
$3,000
21. Refer to Scenario 21-2. If Fred’s wage increases to $90 per hour of writing, which of the following
points would fall on his budget constraint?
a.
75 hours of leisure, $2,775 of consumption
b.
80 hours of leisure, $2,400 of consumption
c.
85 hours of leisure, $2,430 of consumption
d.
90 hours of leisure, $1,650 of consumption
Figure 21-23
A
IC2
IC1
B
Consumption
Leisure
Chapter 21/The Theory of Consumer Choice ❖ 91
22. Refer to Figure 21-23. Fiona experiences an increase in her hourly wage. Her optimal choice point
moves from A to B. For Fiona,
a.
her labor supply curve is backward bending.
b.
her labor supply curve is upward sloping.
c.
leisure is a normal good.
d.
both a and c are correct.
Figure 21-24
23. Refer to Figure 21-24. Anna experiences an increase in her hourly wage. Her optimal choice point
moves from A to B. For Anna,
a.
her labor supply curve is backward bending.
b.
her labor supply curve is upward sloping.
c.
leisure is an inferior good.
d.
both a and c are correct.
24. The two “goods” used when economists analyze labor supply are
a.
work and leisure.
b.
work and consumption.
c.
saving and consumption.
d.
leisure and consumption.
A
IC2
IC1
Consumption
B
Leisure
92 ❖ Chapter 21/The Theory of Consumer Choice
25. Economic theory predicts that an increase in wages
a.
will cause a wage earner to work more.
b.
will cause a wage earner to work less.
c.
will cause a wage earner to be more productive.
d.
might cause a wage earner to work more or work less.
26. The substitution effect of a wage decrease in the work-leisure model results in the worker choosing
to
a.
work less than before.
b.
work more than before.
c.
possibly work more or less than before.
d.
work more with a higher level of consumption.
27. In the work-leisure model, suppose consumption and leisure are both normal goods. The income ef-
fect of a wage increase results in the worker choosing to
a.
work less than before.
b.
work more than before.
c.
possibly work more or less than before.
d.
work more with a higher level of consumption.
28. The labor supply curve may have a backward-bending portion if, at higher wages, the income effect
is
a.
smaller than the substitution effect.
b.
larger than the substitution effect.
c.
negative.
d.
Any of the above could result in a backward-bending supply curve.
29. When leisure is a normal good, the income effect from a decrease in wages is evident in
a.
a desire to consume more leisure.
b.
a desire to consume less leisure.
c.
an upward-sloping labor-supply curve.
d.
a shift in labor demand.
Chapter 21/The Theory of Consumer Choice ❖ 93
30. The substitution effect from an increase in wages is evident in a
a.
decrease in labor demand.
b.
desire to consume less leisure.
c.
desire to consume more leisure.
d.
backward-bending labor supply curve.
31. If leisure were an inferior good, then labor supply curves
a.
would all be negatively sloped.
b.
would all be positively sloped.
c.
would all be vertical.
d.
could still be positively or negatively sloped.
32. A consumer has preferences over consumption and leisure, both of which are normal goods. When
the wage decreases, the consumer chooses to consume less leisure. For this consumer the labor sup-
ply curve will
a.
slope upward.
b.
slope backward.
c.
be horizontal.
d.
be vertical.
33. Suppose that Elmer’s hourly wage increases, and he decides to work fewer hours. For Elmer, the
substitution effect of the wage change is
a.
only partially offset by the income effect.
b.
more than offset by the income effect.
c.
exactly offset by the income effect.
d.
We do not have enough information with which to answer the question.
34. In the upward-sloping portion of the individual labor-supply curve, the substitution effect is
a.
greater than the income effect.
b.
less than the income effect.
c.
equal to the income effect.
d.
exactly offset by the income effect.
94 ❖ Chapter 21/The Theory of Consumer Choice
35. Ryan experiences an increase in his wages. The hours of labor that he supplies to the market would
increase if
a.
the income effect is larger than the substitution effect.
b.
the substitution effect is larger than the income effect.
c.
neither the income effect nor the substitution effect apply to Tom’s labor-leisure tradeoff.
d.
Ryan views both labor and leisure as inferior goods.
36. Jake experiences an increase in his wages. The hours of labor that he supplies to the market would
decrease if
a.
the income effect is larger than the substitution effect.
b.
the substitution effect is larger than the income effect.
c.
neither the income effect nor the substitution effect apply to Harry’s labor-leisure tradeoff.
d.
Jake views both labor and leisure as inferior goods.
37. Which of the following statements is not correct?
a.
If Jane gets a higher wage and works more, the substitution effect is greater than the
income effect for her.
b.
If Spencer experiences a wage decrease and works less, the income effect is greater than
the substitution effect for him.
c.
If the substitution effect is greater than the income effect, the labor-supply curve is upward
sloping.
d.
If the income effect is greater than the substitution effect, the labor-supply curve is
downward sloping.
38. Economic studies of lottery winners and people who have inherited large amounts of money show
that
a.
the income effect of winning the lottery or inheriting large amounts of money likely
outweighs the substitution effect for most people.
b.
the substitution effect of winning the lottery or inheriting large amounts of money likely
outweighs the income effect for most people.
c.
most people view leisure as an inferior good.
d.
most people’s labor supply is unaffected by changes in wealth.
Chapter 21/The Theory of Consumer Choice ❖ 95
39. Which of the following examples would illustrate a backward-sloping labor supply-curve?
a.
An increase in a person’s wages results in the person working fewer hours per week.
b.
A decrease in a person’s wages results in the person working more hours per week.
c.
An increase in a person’s wages results in the person working more hours per week.
d.
Both a and b are correct.
Scenario 21-3
Zach knows that he will ultimately face retirement. Assume that Zach will experience two periods in
his life, one in which he works and earns income, and one in which he is retired and earns no
income. Zach can earn $250,000 during his working period and nothing in his retirement period. He
must both save and consume in his work period with an interest rate of 10 percent on savings.
40. Refer to Scenario 21-3. Assume that Zach decides to consume $100,000 in the work period. How
much money will he have available for consumption in his retirement period?
a.
$100,000
b.
$110,000
c.
$150,000
d.
$165,000
41. Refer to Scenario 21-3. If the interest rate on savings increases, it is possible that
a.
Zach will decrease his savings in the work period.
b.
Zach will increase his savings in the work period.
c.
Zach will not change his consumption in the work period.
d.
All of the above are possible.
42. Refer to Scenario 21-3. If the interest rate on savings increases,
a.
Zach will decrease his savings in the work period if the income effect is greater than the
substitution effect for him.
b.
Zach will increase his savings in the work period if the income effect is greater than the
substitution effect for him.
c.
Zach will increase his savings in the work period if the substitution effect is greater than
the income effect for him.
d.
Both a and c are correct.
96 ❖ Chapter 21/The Theory of Consumer Choice
Figure 21-25
The figure below illustrates the preferences for a representative consumer, Christopher.
43. Refer to Figure 21-25. Interest rates increase by 3 percent. Christopher’s optimal choice point
moves from A to B. Christopher consumes
a.
less while he is younger and saves more than he did before interest rates increased.
b.
more while he is younger and saves more than he did before interest rates increased.
c.
less while he is younger and saves less than he did before interest rates increased.
d.
more while he is younger and saves less than he did before interest rates increased.
Figure 21-26
The figure below illustrates the preferences of a representative consumer, Carlos.
A
IC2
IC1
B
Consumption
when old
Consumption
when young
A
IC2
IC1
Consumption
B
when old
Consumption
when young
Chapter 21/The Theory of Consumer Choice ❖ 97
44. Refer to Figure 21-26. Interest rates increase by 4 percent. Carlos’s optimal choice point moves
from A to B. Carlos consumes
a.
less while he is younger and saves more than he did before interest rates increased.
b.
more while he is younger and saves more than he did before interest rates increased.
c.
less while he is younger and saves less than he did before interest rates increased.
d.
more while he is younger and saves less than he did before interest rates increased.
45. Michael faces tradeoffs between consuming in the current period when he is young and consuming
in a future period when he is old. Michael experiences a decrease in the current interest rate he
earns on his savings. Michael will save
a.
less in the current period if the substitution effect is greater than the income effect.
b.
less in the current period if the income effect is greater than the substitution effect.
c.
more in the current period if the substitution effect is greater than the income effect.
d.
more in the current period, regardless of the sizes of the income and substitution effects.
46. When considering household savings, the relative price between consuming when young and con-
suming when old is the
a.
consumption rate.
b.
interest rate that individuals can earn on their private savings.
c.
prime rate.
d.
federal funds rate.
47. If the interest rate rises, an individual could choose to
a.
increase consumption when young.
b.
increase consumption when old.
c.
decrease consumption when young.
d.
Any of the above could be correct.
48. The substitution effect of an increase in the interest rate will result in an increase in
a.
consumption when young and increase in savings when young.
b.
consumption when old and an increase in savings when young.
c.
consumption when young and an increase in savings when old.
d.
savings when old and an increase in consumption when old.