Question

1. Briefly describe one example of the substitution effect from your own life.

2. Describe what a complementary good is, and then set forth what happens to the demand for any product when the price of its complementary good increases.

3. With respect to consumers, when the price of a good is more elastic, what does this mean, and when the price of a good is more inelastic, what does this mean?

4. What is behavioral economics, and what is the basic technique or method used to engage in behavioral economics?

5. With respect to producer prices, what signals do businesses receive from a more elastic demand, and what signals do they receive from a more inelastic demand?

Answer 1

Ans) Substitution effect in simple words, is turning towards a different product which is similar in nature, due to an increase in the price of a product that was usually bought. For example. A person may have been buying Levis shirts previously, but due to an increase in the price, now buys a shirt similar in nature of a different brand. This is a pretty common phenomena, and substitution effect can be applied in the lives of people with limited income.

A complementary good is a good which is made use of along or in conjunction with the actual product. It basically does not have any value of its own, but when used in combination of some other good or service, adds a value to the overall offering. The demand for a good decreases when there is an increase in the price of another good. For example, If goods X and Y are complements, any increase in the price of X will result in a leftward movement along the demand curve of X and cause the demand curve for Y to shift in.

Price elasticity of demand, is used to illustrate the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price.

The decision making processes in economics of individuals and institutions in relation to the study of psychology can be termed as Behavioral Economics. This theory is heuristics, which uses the thumb rules or mental shortcuts to make a quick decisions. Behavioral game theory, can also be applied to behavioral economics.