Raj consumes only cheese and crackers. a. Could cheese and crackers both be inferior goods for Raj? Explain. b. Suppose that cheese is a normal good for Raj while crackers are an inferior good. If the price of cheese falls, what happens to Raj's consumption of crackers? What happens to his consumption of cheese? Explain.

Understanding the price effect on demand is essential in economics. It explains how consumers' demand for a product changes in response to a change in its price. When the price of a good decreases, two things could happen: consumers may feel as though they have more purchasing power, which is known as the income effect, or they may switch from other goods, which is the substitution effect.

For instance, if the price of cheese falls, Raj feels like his income has gone further, allowing him to buy more cheese or save money. This scenario illustrates the income effect. Alternatively, if Raj views cheese as more affordable compared to other foods, he might purchase more cheese instead of other items, showcasing the substitution effect. The overall change in Raj's demand for cheese due to its price change represents the price effect on demand.

Distinguishing between normal and inferior goods is critical in understanding consumer behavior. Normal goods see an increase in demand as consumer incomes rise. People tend to purchase more of these goods because they view them as desirable and of higher quality.

Inferior goods, however, exhibit the opposite pattern. As incomes increase, demand for inferior goods falls since consumers can afford better alternatives and might associate inferior goods with lower quality. In the exercise with Raj, cheese is considered a normal good, meaning Raj would demand more cheese as his income rises or if cheese becomes cheaper. Conversely, for Raj, crackers are an inferior good, suggesting he might opt for a different snack as his wealth grows.

The income effect in economics is a part of the price effect on demand that occurs when the perceived income of consumers changes due to price variations. If the price of a good like cheese drops, Raj experiences an increase in his real income, as he can maintain his consumption level of cheese while spending less, or he could choose to consume more cheese without altering his expenditure.

As cheese is a normal good for Raj, the income effect would lead him to purchase more of it as it becomes more affordable or as his actual income grows. This effect highlights how consumption patterns shift not due to a change in actual income, but because of the altered buying power the consumer experiences.

The substitution effect is another crucial component of the price effect on demand which occurs when consumers replace more expensive items with less costly alternatives. In our scenario, if the price of cheese falls, Raj might see cheese as more attractive compared to its substitutes. This would prompt him to substitute cheese for other goods, increasing his consumption of cheese while potentially decreasing his consumption of substitute goods.

However, the nature of crackers as an inferior good for Raj introduces complexity. If cheese and crackers are substitutes, the decrease in cheese price will likely cause Raj to buy less crackers, amplifying the substitution effect. Conversely, if they are complements, Raj might end up buying more crackers to accompany his increased intake of cheese, although this would generally be less likely for inferior goods.