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Charlie consumes apples and bananas. His utility function is: U(xA; xB) xAxB. The price of apples is $1, the price of bananas is $2, and Charlies income is $40 a day. The price of bananas suddenly falls to $1. Find the substitution and income effect of the price change for apples and bananas.
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Answer #1

The change in demand due to change in rate of exchange is called substitution effect while change in demand due to change in purchasing power is called income effect.

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