Exercise B6

What is a substitution effect?

Exercise B7

What is an income effect?

Exercise B8

Does the “income effect” involve a change in income? Explain.

Exercise B9

Does a change in price have both an income effect and a substitution effect? Does a change in income have

both an income effect and a substitution effect?

Exercise B10

Would you expect, in some cases, to see only an income effect or only a substitution effect? Explain.

Exercise B11

Which is larger, the income effect or the substitution effect?

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C • Present Discounted Value 533

APPENDIX C

Present Discounted Value

As explained in Financial Markets, the prices of stocks and bonds depend on future events. The price of a bond

depends on the future payments that the bond is expected to make, including both payments of interest and

the repayment of the face value of the bond. The price of a stock depends on the expected future profits earned
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