Substitution and Income Effects
BUS 640: Managerial Economics
November 1, 2012
Gas prices have continued to increase over the last seven years, which has drastically changed the way people spend money. In just the last week, the price of gas per gallon fluctuated 50 cents a gallon, making it difficult for consumers to budget their gas spending. Regardless of the price of gas, few Americans are likely to drive less, but rather cut spending in other portions of their household budget. 70 percent of Americans are more likely to cut back on entertainment, 60 percent will change vacation plans, and 64 percent will postpone a major purchase before they change their driving and transportation habits (Anonymous, 2007). Overall, 61 percent were not at all likely to walk or ride a bicycle instead of drivel; only one in four are somewhat likely to take public transportation; and, less than half would car pool as a means to curb gas spending (Anonymous, 2007).
80 percent of Americans feel that their car is very important to their everyday life (Anonymous, 2007). They prove this in their unwillingness to change their driving habits even when gas prices increase and by the fact that 36 percent of American households spend more than $200 a month on gasoline for their vehicles. The American people are dependent on their personal transportation and find the convenience of personal transportation more important than most other things in their household budget. The student is not much different from the national averages and this article will explain the student’s purchasing decisions based on the assumption that the price of gas has increased 100% during one difficult summer. In analyzing the options for the student’s budget, the student will view the choices and options in terms of the income effect, the substitution effect, or both. The substitution effect is “the change in the consumption of a good that...
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