6.2 Income and Substitution Effects of Price Changes

Question 1

what is real income?

Answer 1

Real income is income expressed in terms of the purchasing power of money income—that is, the quantity of goods and services that can be purchased with the money income.

Question 2

what is the Substitution Effect?

Answer 2

The substitution effect
is the change in the quantity of
a product demanded resulting from a change in its relative price (holding real income constant).

Question 3

The substitution effect on quantity demanded

Answer 3

The substitution effect increases the quantity demanded of a product whose price has fallen and reduces the quantity demanded of a product whose price has risen. (ordinary goods)

Question 4

what is the Income Effect?

Answer 4

The income effect is the change in the quantity of a product demanded resulting from a change in real income (holding relative prices constant).

Question 5

Income effect on consumers?

Answer 5

The income effect leads consumers to buy more of a product whose price has fallen, provided that the product is a normal good. The size of the income effect depends on the amount of income spent on the product whose price changes and on the amount by which the price changes.

Question 6

The Slope of the Demand Curve is negative because?

Answer 6

it is negatively sloped because:
1-if it’s less expensive, I want to consume more of it relative to the other goods (substitution effect)
2-if it’s less expensive, I am richer ( in real terms) so since it’s a normal good, I tend to buy more of it. A fall in price will increase the quantity demanded.

Question 7

The slope of the Demand Curve for Giffen goods?

Answer 7

The demand curve is positively sloped because:
1- if it’s less expensive, I want to consume more of it relative to the other goods (substitution effect)
2- if it’s less expensive, I am richer (in real terms), so since it’s a really inferior good, I tend to buy less of it, and the effect is so large that it compensates the substitution effect.