1

Changes In Income

• A rise in income - with no change in price - leads to a new quantity demanded for each good– Normal good

• quantity demanded increases

– Inferior good• quantity demanded decreases

– Depends on the individual’s preferences

2

Changes In Income

• Initial Income= $150; • New Income = $300 per month• Pconcert=$30; Pmovie=$10

• Figure 5 Effects of an Increase in Income

3

Changes In Income

1. When Max's income rises to $300, his budget line shifts outward.

H'

H''

H

30

27

15

12

9

6

3

1 2 3 4 5 6 7 8 9 10 Number of Concerts per Month

Number of Movies per

Month

2. If his preferences are as given in the table, he'll choose point H

3.But different marginal utility numbers could lead him to H' or H''

AB

C

DE

F

• Figure 5 Effects of an Increase in Income

4

Changes In Price

• Rotates the budget line rightward• The consumer will select the

combination of movies and concerts– On his budget line

– Makes him as well off as possible

– Marginal utility per dollar spent on both goods is the same

5

Changes In Price

• Income = $150 per month• Initial: Pconcert=$30; Pmovie=$10; • Change: Pconcert=$10; Pmovie=$10

• Figure 6 Deriving the Demand Curve

6

Deriving the Demand Curve

JD

D

JK

2. If the price falls to $10, Max's budget line rotates rightward, and he chooses point J.

3. And if the price drops to $5, he chooses point K.Price per

Concert$30

105

3 7 10 Number of Concerts per Month

15

6

3 5 15 300

108

7 10

Number of Movies per

Month K

4. The demand curve shows the quantity Max chooses at each price.

1. When the price of concerts is $30, point D is best for Max.

• Figure 6 Deriving the Demand Curve

7

The Substitution Effect

• As the price of a good falls, the consumer substitutes that good in place of other goods whose prices have not changed.– Change in the relative price

– Price decreases - increase quantity demanded

– Price increases - decrease quantity demanded

8

The Income Effect

• As the price decreases - increase purchasing power– Normal goods - increase quantity

demanded

– Inferior goods - decrease quantity demanded

• Price increases - decrease purchasing power

9

Combining Substitution and Income Effect

• Normal Goods– Substitution and income effects work

together

– Must always obey the law of demand

• Inferior Goods– Substitution and income effects work

against each other

– The substitution effect dominates

– Virtually always obey law of demand

10

Income and Substitution Effects

Price Decrease:

P

Purchasing Power

QD

QD

QD

if normalif inferior

Substitution EffectUltimate Effect(Almost Always)

QD

Price Increase:

P QD

QD

QD

if normal

if inferior

Substitution Effect

QDPurchasing

Power

• Figure 7 Income and Substitution Effects

11

Consumers in Markets

Number of Bottles per Week

C

4 12

JerryPrice

$4

0

3

2

1

C'

GeorgePrice

0 6 12

$4

3

2

1

C''

ElainePrice

0 10 20

$4

3

2

1

+ + =

• Figure 8 From Individual to Market Demand

12

Deriving the Market Demand Curve

A

C

B

D

E

Market Demand Curve- obtained by adding up the total quantity demanded by all market participants at different prices

Price

$4

3

2

1

3 10 27 44

Number of Bottles per Week

• Figure 8 From Individual to Market Demand