Lecture 12 - Announcements MT1 is next Wednesday. Please...

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Announcements MT1 is next Wednesday. Please e-mail me ASAP about conflicts. Practice exam on Scholar. Study first then take it as an “exam” (timed, no notes) These notes are for today and half of Friday We will also intro chapter 7 on Friday (not on this exam)
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Price Changes Let’s talk a bit more about what happens when the price of a good that we buy changes (we’ve seen some of this before).
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The Income and Substitution Effects of a Price Change When the price of one of the goods you buy changes, it has two separate effects on your consumption: 1.INCOME EFFECT 2.SUBSTITUTION EFFECT
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INCOME AND SUBSTITUTION EFFECTS THE INCOME EFFECT When the price of something we buy falls, we are better off . Our REAL INCOME (income in terms of what we can buy) rises as prices fall. As real income rises, we want to buy more of all normal goods. When the price of something we buy rises, we are worse off . Our REAL INCOME falls and we want to buy less of all normal goods.
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INCOME AND SUBSTITUTION EFFECTS THE SUBSTITUTION EFFECT If the price of one good falls (ceteris paribus), that good becomes less expensive relative to substitutes. If this happens we are likely to buy more of the good whose price fell and less of other goods (to equalize MU/P). If the price of one good rises (ceteris paribus), that good becomes more expensive relative to substitutes. If this happens we are likely to buy less of the good whose price fell and more of other goods (to equalize MU/P).
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INCOME AND SUBSTITUTION EFFECTS… …AND DOWNWARD SLOPING DEMAND Both the income and the substitution effects imply a negative relationship between price and quantity demanded —in other words, downward-sloping demand. price of something falls ceteris paribus real income rises buy more of that good (and all normal goods)= (income effect). Price falls less expensive relative to substitutes buy more of the good whose price fell =(substitution effect). price of something rises ceteris paribus real income falls buy less of that good (and all normal goods)= (income effect). Price rises more expensive relative to substitutes buy less of the good whose price rose =(substitution effect).
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INCOME AND SUBSTITUTION EFFECTS Income and Substitution Effects of a Price Change
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INCOME AND SUBSTITUTION EFFECTS So both the income and substitution effects say that is price of a good falls (rises), you will buy more (less) of that good. BUT, the income effect says that since
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This note was uploaded on 12/20/2011 for the course ECON 2005 taught by Professor Zirkle during the Fall '07 term at Virginia Tech.

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Lecture 12 - Announcements MT1 is next Wednesday. Please...

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