Substitution and Income Effects

Topics: Consumer theory, Automobile, Economics Pages: 4 (1208 words) Published: July 12, 2010
Substitution and Income Effects

This paper examines the effects of gasoline price increase over the period of a summer. It looks at the income effect and substitution effect of different scenarios to determine how the author should best make up the difference in cost based on the same income. Seven scenarios are examined; driving less, eating out less, less spent on maintenance, public transportation, bicycle, no vacation and fewer extra expenses. Using graphs to demonstrate the income effect and substitution effect, it is easier to see which is the best solution.  Substitution and Income Effects

Substitution and income effects are a part of everyday life. This paper examines the substitution and income effects of gasoline prices. The author currently spends $120 on gasoline per month, 4 weeks. Assuming that there is a price increase of 100% during one summer, then the cost of those 3 months for gasoline to drive the same amount would be $240 per month, or $720 for the summer, 12 weeks. The automobile driven gets 30 miles per gallon of gasoline. During the spring gasoline cost $3.00 per gallon and during the summer gasoline costs rose to $6.00 per gallon. Thomas and Maurice state that “when the price of a good increases, consumers are worse off” and in this instance, the increase in gasoline prices makes it necessary to adjust the monthly budget (2011, p 186-187). Using either the substitution effect or the income effect, there are a number of ways to evaluate how to afford gasoline. Some sacrifices will have to be made, but budgeting accordingly and making sacrifices allows for the author to afford the increase in gasoline prices. Drive less

If the author were to drive less during the summer months, then they would be able to save money. This would fall under the income effect, or “the change in the consumption of a good resulting strictly from a change in purchasing power after the price of a good changes” (p. 188). For...
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