Price Fall Effects on Demand
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A change in the price of a product (other factors remaining constant) creates an income effect and a substitution effect!
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Price Fall Effects on Demand
- 2. A change in the price of a product (other factors remaining constant) creates an income effect and a substitution effect!
- 3. Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect Bananas Oranges IC1 BL1 A
- 4. Bananas Oranges IC1 BL1 BL2 A Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 5. Bananas Oranges IC1 BL1 BL2 IC2 A Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 6. Bananas Oranges IC1 BL1 BL2 IC2 A Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 7. Bananas Oranges IC1 BL1 BL2 IC2 A C Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 8. Bananas Oranges IC1 BL1 BL2 IC2 A C Cheaper oranges – leads to an expansion of demand Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 9. Bananas Oranges IC1 BL1 BL2 IC2 A C How much is due to? 1. Oranges now relatively cheaper than bananas? Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 10. Bananas Oranges IC1 BL1 BL2 IC2 A C How much is due to? 1. Oranges now relatively cheaper than bananas? 2. Real income has increased with price fall Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 11. Bananas Oranges IC1 BL1 BL2 IC2 A C To eliminate the income effect – hold consumer to their initial indifference curve (IC1) .. Do this by creating shadow budget line with new relative prices Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 12. Bananas Oranges IC1 BL1 BL2 IC2 A C Consumers buy more oranges because they are now cheaper than bananas Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 13. Bananas Oranges IC1 BL1 BL2 IC2 A B C Consumers buy more oranges because they are now cheaper than bananas Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 14. Bananas Oranges IC1 BL1 BL2 IC2 A B C Consumers buy more oranges because they are now cheaper than bananas Movement from A to B is the substitution effect Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 15. Bananas Oranges IC1 BL1 BL2 IC2 A B C Substitution effect: From A to B Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 16. Bananas Oranges IC1 BL1 BL2 IC2 A B C Now allow the consumer to move onto the higher indifference curve IC2 Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 17. Bananas Oranges IC1 BL1 BL2 IC2 A B C Substitution effect: From A to B Income effect: from B to C Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 18. Bananas Oranges IC1 BL1 BL2 IC2 A B C Substitution effect: From A to B Income effect: from B to C Total effect of price fall: from A to C Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect
- 19. Bananas Oranges IC1 BL1 BL2 IC2 A B C In this example, the income effect and the substitution effect are working in the same direction when oranges become cheaper - i.e. both cause more to be bought Cheaper Oranges – Income & Substitution Effects This analysis breaks down the effect of a fall in the market price of oranges into an income effect and a substitution effect