Changes In Income A rise in income - with no change in price - leads to a new quantity demanded for each good Normal good quantity demanded increases Inferior good quantity demanded decreases Depends on the individual’s preferences

Changes In Income Figure 5 Effects of an Increase in Income Initial Income= $150; New Income = $300 per month Pconcert=$30; Pmovie=$10

Changes In Income Figure 5 Effects of an Increase in Income 30 27 15 12 9 6 3 1 2 4 5 7 8 10 Number of Concerts per Month Number of Movies per Month H'' 2. If his preferences are as given in the table, he'll choose point H 1. When Max's income rises to $300, his budget line shifts outward. A B C D E F H 3.But different marginal utility numbers could lead him to H' or H'' H'

Changes In Price Rotates the budget line rightward The consumer will select the combination of movies and concerts On his budget line Makes him as well off as possible Marginal utility per dollar spent on both goods is the same

Changes In Price Figure 6 Deriving the Demand Curve Income = $150 per month Initial: Pconcert=$30; Pmovie=$10; Change: Pconcert=$10; Pmovie=$10

Deriving the Demand Curve Figure 6 Deriving the Demand Curve 1. When the price of concerts is $30, point D is best for Max. 15 6 3 5 30 10 8 7 Number of Movies per Month 2. If the price falls to $10, Max's budget line rotates rightward, and he chooses point J. K D J 3. And if the price drops to $5, he chooses point K. Price per Concert $30 10 5 3 7 Number of Concerts per Month D 4. The demand curve shows the quantity Max chooses at each price. J K

The Substitution Effect As the price of a good falls, the consumer substitutes that good in place of other goods whose prices have not changed. Change in the relative price Price decreases - increase quantity demanded Price increases - decrease quantity demanded

The Income Effect As the price decreases - increase purchasing power Normal goods - increase quantity demanded Inferior goods - decrease quantity demanded Price increases - decrease purchasing power

Combining Substitution and Income Effect Normal Goods Substitution and income effects work together Must always obey the law of demand Inferior Goods Substitution and income effects work against each other The substitution effect dominates Virtually always obey law of demand

Income and Substitution Effects Figure 7 Income and Substitution Effects Price Decrease: Ultimate Effect (Almost Always) Substitution Effect P QD Þ QD QD if normal Purchasing Power QD if inferior Price Increase: Substitution Effect P QD Þ QD QD if normal Purchasing Power QD if inferior

Consumers in Markets + + = Figure 8 From Individual to Market Demand 4 12 Jerry Price $4 3 2 1 George Price 6 12 $4 3 2 1 Elaine Price 10 20 $4 3 2 1 + + = C C' C'' Number of Bottles per Week

Deriving the Market Demand Curve Figure 8 From Individual to Market Demand Price $4 3 2 1 10 27 44 Number of Bottles per Week A Market Demand Curve - obtained by adding up the total quantity demanded by all market participants at different prices B C D E