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microbook_3e-page65 - Income Effect on Inferior Goods If...

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Effects of a Price Change x Income Effect – occurs when real income (purchasing power) changes holding the relative price constant. x Substitution Effect – occurs when the relative price changes holding real income (purchasing power) constant. Income Effect on Normal Goods When a consumer’s money income rises or falls, his/her purchasing power is obviously affected, but here we want to analyze the case of price changes, so we’ll focus on the case where money income is being held constant. If goods X and Y are both “normal goods ,” then: x when the price of X falls, the income effect encourages the consumer to use his/her higher real income to buy more of both X and Y. x when the price of X rises, the income effect encourages the consumer to reallocate his/her lower real income by buying less of both X and Y.
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Unformatted text preview: Income Effect on Inferior Goods If good X is an “inferior good ,” then when the price of good X falls, the income effect encourages the consumer to use his/her higher real income to buy less of X and more of Y. Substitution Effect on Net Substitutes When there are only two goods, they must be net substitutes. We’ll leave a discussion of net complements to a more advanced course. Since goods X and Y are net substitutes: x when the price of good X falls, it becomes more attractive relative to good Y, so the substitution effect encourages the consumer to buy more of X and less of Y. x when the price of good X rises, it becomes less attractive relative to good Y, so the substitution effect encourages the consumer to buy less of X and more of Y. Page 65...
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This note was uploaded on 12/29/2011 for the course ECO 311 taught by Professor Willis during the Fall '10 term at SUNY Stony Brook.

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