Income and substitution

effects
 Income is the sum of all households
wages, salaries, profits, interest
payments, rents, and other forms of
Income earnings in a given period of time. It is a
and flow measure.
Wealth Wealth, or net worth, is the total
value of what a household owns
minus what it owes. It is a stock
measure
2
 Normal Goods are goods for
which demand goes up when
income is higher and for which
Related demand goes down when income
goods is lower.
and
Services
Inferior Goods are goods for which
demand falls when income rises
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 Substitutes are goods that can serve as
replacements for one another; when the
price of one increases, demand for the
Related other goes up. Perfect substitutes are
goods identical products.
and Complements are goods that “go
Services together”; a decrease in the price of one
results in an increase in demand for the
other, and vice versa.
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 THE SUBSTITUTION EFFECT
of a price change arises from a change in the relative price of
a good, and it always moves quantity demanded in the
opposite direction to the price change. When price decreases,
the substitution effect works to increase quantity demanded;
when price increases, the substitution effect works to decrease
quantity demanded.

5
 Substitution effect As the price
of a good falls, the consumer substitutes that good in place of
other goods whose prices have not changed.

6
 Cheaper cell phone
calls, and the
substitution effect,
have almost
completely driven pay
phones like this out of
the market.
7
 1.
THE INCOME EFFECT
As the price of a good decreases, the consumer’s purchasing
power increases, causing a change in quantity demanded for
the good.

8
“

9
 An increase in income will:

✘ increase the demand for normal goods and decrease the demand for
inferior goods.
✘ The same is true for the income effect of a price cut: It can work to either
increase or decrease the quantity of a good demanded, depending on
whether the good is normal or inferior.

10
COMBINING SUBSTITUTION AND INCOME EFFECTS

11
For normal goods,
the substitution and
income effects work
together, causing
quantity demanded
to move in the
opposite direction of
the price. Normal
goods, therefore,
must always obey
the law of demand.

12
For inferior goods, the substitution and income effects of a price
change work against each other. The substitution effect moves
quantity demanded in the opposite direction of the price, while
the income effect moves it in the same direction as the price. But
since the substitution effect virtually always dominates,
consumption of inferior goods—like normal goods—will
virtually always obey the law of demand.

13
 In two or three columns

Yellow Blue Red

Is the color of gold, butter and Is the colour of the clear sky and Is the color of blood, and because
ripe lemons. In the spectrum of the deep sea. It is located between of this it has historically been
visible light, yellow is found violet and green on the optical associated with sacrifice, danger
between green and orange. spectrum. and courage.

14
A picture is worth a thousand words

A complex idea can be conveyed with

just a single still image, namely
making it possible to absorb large
amounts of data quickly.

15
Want big
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Use big
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Use charts to explain your ideas

White Gray Black

17
 And tables to compare data

A B C

Yellow 10 20 7

Blue 30 15 10

Orange 5 24 16

18
 Maps

our office

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Whoa! That’s a big number, aren’t you proud?

20
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 Our process is easy

first second last

22
 Let’s review some concepts
Yellow Blue Red
Is the color of gold, butter and ripe Is the colour of the clear sky and the Is the color of blood, and because of
lemons. In the spectrum of visible light, deep sea. It is located between violet this it has historically been associated
yellow is found between green and and green on the optical spectrum. with sacrifice, danger and courage.
orange.

Yellow Blue Red

Is the color of gold, butter and ripe Is the colour of the clear sky and the Is the color of blood, and because of
lemons. In the spectrum of visible light, deep sea. It is located between violet this it has historically been associated
yellow is found between green and and green on the optical spectrum. with sacrifice, danger and courage.
orange.

23
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