price change effect on consumption - broken down into 2 parts
- prices change >> income, prices both change relatively
- substitution effect - price changes >> relative prices of good changes
- willing to buy more of good that became relatively cheaper
- price change for 1 good relatively effects the other good as well
- utility stays constant, price declines >> demand increases
- causes shift along indifference curve (to point where more of one good bought than before)
- income effect - price falls >> relative income increases >> increase in real purchasing power
- price held constant (as if income increased), quantity demanded depends on whether good is inferior/normal
- outward or inward shift to new demand curve
- inferior good >> inward shift >> may or may not overtake substitution effect
- may be large enough to cause demand to slope upward (stop consuming some other good completely
- substitution effect
- indifference curve
- initial budget line
- new, relative budget line
- though the absolute price of good 2 doesn't change, a price decrease for good 1 makes good 2 relatively more expensive >> new relative budget line
- income effect
- price decrease for good 1 leads to an overall increase in purchasing power
- new budget line shifts outward from relative budget line found in last step
- negative income effect >> inferior good
- Giffen good - causes demand curve to slope upward due to very large income effect (very rare)
- overall change
- as expected, a price decrease for good 1 leads to more of good 1 and less of good 2 being bought
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