Example Income and Subsitution Effects For Normal and Inferior Goods

Summary

This tutorial delves into the income and substitution effects in consumer theory, using numerical examples. It explores how a price decrease for a normal good leads to increased consumption due to both income and substitution effects, while for an inferior good, consumption may paradoxically decrease despite the price drop. The video also examines the effects of a price increase, showing a decrease in consumption for normal goods and an increase for inferior goods. The tutorial visually demonstrates these concepts with budget lines and indifference curves, providing a clear understanding of consumer behavior in response to price changes.

Takeaways

• 📈 The tutorial discusses income and substitution effects in consumer theory, using numerical examples to illustrate the concepts.
• 📉 The presenter demonstrates the effects of a price decrease for a normal good, showing how the quantity demanded increases.
• 🔄 The total effect of a price change is broken down into substitution and income effects, highlighting how each contributes to the change in quantity demanded.
• 📊 A visual representation with budget lines and indifference curves is used to explain the consumer's choice before and after a price change.
• 🔽 For a normal good, a price decrease leads to an increase in quantity demanded due to both the substitution and income effects.
• 🔼 The tutorial also covers the case of an inferior good, where a price decrease results in a decrease in quantity demanded due to the income effect outweighing the substitution effect.
• 📌 The substitution effect is shown as the change in quantity demanded moving along the original indifference curve to a new point where it is tangent to the new budget line.
• 💰 The income effect is illustrated as the change in quantity demanded moving from the original point to the new point along the new budget line.
• 📈 The effects of a price increase for both normal and inferior goods are discussed, showing opposite reactions in quantity demanded.
• 🔗 The tutorial concludes by summarizing the income and substitution effects for normal and inferior goods under different price scenarios.

Q & A

What are the income and substitution effects discussed in the tutorial?

The tutorial discusses the income and substitution effects when the price of a good changes. The income effect refers to the change in consumption due to a change in purchasing power, while the substitution effect refers to the change in consumption due to the relative price change between goods.

How does the price decrease of a normal good affect its consumption?

When the price of a normal good decreases, consumers can buy more of it, leading to an increase in consumption. This is shown in the tutorial by the outward rotation of the budget line and the consumer moving to a new consumption point with more units of good-x.

What is the total effect of a price decrease for a normal good?

The total effect of a price decrease for a normal good is the change in the quantity consumed from the initial to the new consumption point, which in the tutorial is calculated as 17 units minus 4 units, equaling a total effect of 13 units.

How is the substitution effect for a normal good calculated in the tutorial?

The substitution effect for a normal good is calculated by determining the quantity of good-x consumed at the point where the new budget line is tangent to the original indifference curve, which is 10 units in the tutorial, resulting in a substitution effect of 10 minus 4 units.

What is the income effect when the price of a normal good decreases?

The income effect when the price of a normal good decreases is the change in consumption from the original point to the point where the new budget line is tangent to the original indifference curve, which is 17 minus 10 units in the tutorial, resulting in an income effect of 7 units.

How does the price decrease of an inferior good affect its consumption?

For an inferior good, a price decrease leads to an increase in consumption, but the increase is less than what would be expected for a normal good. This is due to the good being considered less desirable, and consumers substitute towards normal goods as their income effectively increases.

What is the total effect of a price increase for a normal good?

The total effect of a price increase for a normal good is the decrease in the quantity consumed from the initial to the new consumption point, which in the tutorial is calculated as 4 units minus 14 units, equaling a total effect of -10 units.

How is the substitution effect for an inferior good calculated when the price increases?

The substitution effect for an inferior good when the price increases is calculated by determining the quantity of good-x consumed at the point where the new budget line is tangent to the original indifference curve, which is 7 units in the tutorial, resulting in a substitution effect of 7 minus 14 units.

What is the income effect when the price of an inferior good increases?

The income effect when the price of an inferior good increases is the change in consumption from the original point to the point where the new budget line is tangent to the original indifference curve, which is 8 minus 7 units in the tutorial, resulting in an income effect of 1 unit.

Why does the income effect differ between normal and inferior goods?

The income effect differs between normal and inferior goods because consumers react differently to changes in purchasing power. For normal goods, an increase in purchasing power leads to more consumption, while for inferior goods, it leads to less consumption as consumers substitute towards higher-quality goods.