Differentiate between an income effect and a substitution effect. ...

[tfester]

Differentiate between an income effect and a substitution effect.
 
  What will be an ideal response?

Question 2

If revenue in the short run is sufficient to offset variable costs but not all fixed costs, what should the firm do?
 
  What will be an ideal response?

[tandmlomax84]

Answer to Question 1

Ceteris paribus, the income effect of a price decrease increases the opportunity to buy more of all goods, whereas the substitution effect of a price decrease makes the good become relatively cheaper. In the case of a price increase, the income effect reduces the opportunity to buy all goods, whereas the substitution effect makes the good become relatively more expensive.

Answer to Question 2

The firm should continue to produce in the short run but exit in the long-run if it expects economic losses to continue.