Today's Question
When a price changes, two things happen simultaneously. The 'substitution effect': the good becomes relatively cheaper/more expensive compared to alternatives. The 'income effect': your purchasing power changes. If gasoline prices drop 50%, explain both effects. How might someone who HATES driving still end up driving more?
Model Answer
Substitution effect: Gas is now cheaper relative to bus tickets or flights - you substitute toward driving. Income effect: You have more purchasing power overall (like a raise!), so you might travel more in general. The driving-hater might drive more because: (1) substitution - it's now relatively attractive vs other transport, (2) income - they feel 'richer' and take more trips overall, some by car. Both effects push toward more driving.