Economics-Substituion and Income Effects

Topics: Consumer theory, Indifference curve, Budget constraint Pages: 4 (1127 words) Published: October 31, 2011
Substitution and Income Effects Paper

Substitution and Income Effects Paper
Substitution and Income effects are part of everyone’s everyday life, without anyone really realizing. The substitution effect takes place on the same indifference curve, while the income effect takes place on a higher or lower indifference curve depending on the change in price (Thomas and Maurice, 2011). For the specific example of the price of gas rising by over 100%, examples that demonstrate the income effect would have a lower indifference curve than the normal one. For the substitution effect the same amount of products are still being consumed, however what changes is that if the price of one goes down then they will probably purchase more of that and less of the other product that has the same price as before (Substitution Effect, 2011). The opposite is true that if the price of a product increases then the consumer will probably buy more of the product that has the same price as before than they did previously because they can’t spend as much money on the product with the increased price (Microeconomics Consumer Behavior: Income and Substitution Effects, 2010; Thomas and Maurice, 2011). A. Driving Less

In this scenario the consumer is decreasing overall consumption by driving their car less so they can therefore consume less gas. In the graph shown below, the purple line indicates the normal amount of driving that the consumer takes part in (Figure 1). The red line represents the substitution effect that is occurring in this scenario. This effect would indicate that since less gas was being consumed that in turn more driving was taking place, obviously this would not occur. The Income effect would be the dominate effect in the circumstance demonstrating less driving occurring with less gas being consumed (Thomas and Maurice, 2011). Figure 1: Amount of driving

B. Eating out less often:
To make up for the higher gas prices one effect would be...
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