incomesubsteffects - Income and Substitution Effects Q hot...

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Income and Substitution Effects
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Q donuts Q hot chocolate 1 3 Normal good with a DECREASE in price: Price of donuts decreases , so the budget line rotates outward. The consumer equilibrium moves from point 1 to point 3. Lower prices increase the consumer’s utility. IC2 IC1
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1 to 2: substitution effect (lower relative price of donuts encourages an increase in donut consumption and a decrease in hot chocolate) 2 to 3: income effect (higher purchasing power encourages an increase in donut and hot chocolate consumption, implying donuts and hot chocolate are normal goods) 1 3 2 Q of donuts Q of hot chocolate The substitution effect focuses just on the change in the slope of the budget line from the change in relative prices (the green dotted line has the same slope as the new budget line, but it’s tangent to the original indifference curve). The income effect focuses just on the increase in purchasing power from lower prices (shift from the green dotted line to the red line).
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Q donuts Q hot
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This note was uploaded on 01/29/2010 for the course MGMT 201 taught by Professor Rowe during the Spring '08 term at Purdue University-West Lafayette.

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incomesubsteffects - Income and Substitution Effects Q hot...

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