Monday

 

Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 7 Topics for Further Study
Chapter 21 of 36 The Theory of Consumer Choice
Section 15 of 26
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Figure 10 – Income and Substitution Effects
The effect of a change in price can be broken down into
· substitution effect
· income effect
The substitution effect is the movement along an indifference curve to a point with a different marginal rate of substitution.
This is shown along indifference curve I1 as the change from point A to B.
The income effect is the shift to a higher indifference curve.
This is shown here as the change
· from point B on indifference curve I1
· to point C on indifference curve I2
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The impact of a change in the price of a good on consumption can be separated into two effects: substitution effect and income effect.
In a consumer’s response to a new lower price of Pepsi, he would reason in the two following ways:
1- substitution effect
Now the price of Pepsi has fallen, I get more pints of Pepsi for every pizza I give up.
Because pizza is now relatively more expensive per unit I should buy less pizza and more Pepsi.
This is the substitution effect, indicated by movement from point A to point B.
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2- income effect
Now Pepsi is cheaper my income has greater purchasing power, in effect I am richer than I was.
Because I am richer I can buy both more pizza and more Pepsi.
This is the income effect, indicated by movement from point B to point C.
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Because Pepsi has become less expensive, the consumer has to give up less pizza to get more Pepsi.
The substitution effect leads the consumer buy less pizza and more Pepsi.
Because of the reduced price of Pepsi the consumer’s income has in effect become greater.
The income effect leads the consumer buy more pizza and more Pepsi.
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He buys more Pepsi because the income and substitution effects both act to raise purchases of Pepsi.
The substitution effect increases his purchases of Pepsi from 10 pints to 20 pints.
The income effect increases his purchases of Pepsi from 20 pints to 30 pints.
The combined two effects increases Pepsi purchases from point A 10 pints to point C 30 pints.
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The substitution effect decreases his purchases of pizza from 16 pizzas to 8 pizzas.
The income effect increases his purchases of pizza from 8 pizzas to 12 pizzas
The combined two effects decreases pizza purchases from point A 16 pizzas to point C 12 pizzas.
Table 1 is a summary of these results: a big Pepsi consumption increase and small pizza consumption decrease.
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the result is ambiguous
kekka wa aimai da
結果は曖昧だ