Introduction

CONSUMER BEHAVIOR

SUBSTITUTION EFFECT AND INCOME EFFECT

SUBSTITUTION EFFECT AND HIKS INCOME EFFECT

SPECIAL OCCASION GOODS – GIFFEN

SUBSTITUTION EFFECT AND INCOME EFFECT ACCORDING TO SLUTSKII

CONSUMER BALANCE

CONCLUSION

APPENDIX

LIST OF USED LITERATURE

Introduction

Decreasing the price of a certain commodity has a twofold effect. First, consumers are able to take advantage of rising real purchasing power. They can buy the same amount of a product for less money, and thus have more money to spend on additional purchases. Secondly, they will consume more of the goods that have fallen in price, and a smaller amount of those goods that have become relatively more expensive.

Any person is well aware of the situation of changing the price of any product. This happens all the time, for various reasons. A change in the price of goods, first of all, affects the welfare of the consumer: when the price of a product that we purchase increases, the welfare of the consumer decreases, and vice versa. In my control work, I considered how a rational consumer (that is, a consumer who maximizes utility) will behave in the current situation (after a decrease or increase in the price of a product). For example, will he spend all the released funds after the price reduction (there is an income effect) on the purchase of the same product or will he behave differently, i.e. there will be a substitution effect.

The purpose of my quiz is to examine in detail the substitution effect and the income effect.

In accordance with the goal, the tasks of the work can be formulated:

Reveal the essence of consumer behavior;

Give the concept of income effect and substitution effect;

Consider the income effect and the Hicks substitution effect;

Consider the income effect and the Slutsky substitution effect;

Define consumer equilibrium.

consumer behavior

Let's assume that a firm has developed a new, improved type of product, the quality of which exceeds the products already produced by it. The firm is faced with the question, at what price to sell this product? How much higher can the price of this product be charged compared to similar products? What price will be acceptable to consumers? How much of the new product will they buy?

To answer these questions, the company must analyze the demand for products, changes in prices and incomes of buyers, determine what factors affect consumer choice.

The main factor in consumer choice is the usefulness of a product. Usefulness is a purely individual concept. What is useful for one person may be completely useless for another. However, even if the product we choose is useful for the consumer, there are circumstances that limit the buyer's ability to purchase it. These constraints are price and income. For example, meat is a very healthy product for most people, but high prices and limited incomes do not allow everyone to consume it in large quantities. At the same time, utility itself changes with an increase in the amount of consumed products.

Marginal utility is the additional utility gained from the consumption of each successive unit of output. In extreme heat, the first glass of sparkling water will have a very high utility, the second - less, and the fifth may be completely useless. Thus, marginal utility is inversely proportional to consumption.

How can the law of diminishing marginal utility be used to explain consumer choice? Suppose we came to the store for shopping, having 350 rubles. Suppose also that there are only two goods: A and B, the prices of which are respectively 50 and 100 rubles. How many units of product A and B will we buy? In other words, how do we allocate our budget for the purchase of these goods, based on their usefulness?

Let's estimate the marginal utility of goods A and B in points, based on our subjective ideas (Table 1). According to our estimate, the purchase of good B will bring us the greatest satisfaction. However, we take into account not only the marginal utility, but also the price of the good. And the price of good B is twice the price of good A. We make a purchase decision based on the utility per unit of money spent, i.e. for 1, rub. Since the marginal utility per 1 rub. will be different, the purchase of three units of product A and two units of product B will satisfy our needs as much as possible.

Any other combination of quantities of goods A and B at existing prices and a certain amount of available funds (350 rubles) will give a lower total utility for the buyer.

Consumer equilibrium is reached when the ratios of the marginal utilities of individual goods to their prices are equal. Denoting the marginal utility through MU (eng. marginalutility), we get the equality

MU A \u003d MU B \u003d ... \u003d MU N P A P B P N

In our example 3 = 6 50 100

What happens if the price of good B is halved? Then for the same 350 rubles. we will buy three units of good A and four units of good B. Thus, when the price decreases, the number of goods purchased will increase.

Substitution effect and income effect

When the price of a commodity decreases, two effects occur. First, the consumer replaces some other goods with a cheaper good, and the demand for this good increases. Secondly, the real income of the buyer increases, so he increases the demand for some goods, to which the cheap goods usually belong. For example, a decrease in the price of chicken (or a slower increase in price) will cause us to buy more chicken than we buy beef or pork.

For normal goods, income and substitution effects explain an increase in demand when prices fall and a decrease in demand when prices rise.

For inferior goods, the situation depends on the extent to which each of these effects affects consumer choice. If the substitution effect is stronger than the income effect, then the demand curve for the inferior good will have the same shape as for the normal good. For example, with the rise in prices for butter, we began to buy more relatively cheap margarine. If the impact of the income effect is higher than the substitution effect, the reverse is observed: as the price increases, the consumption of the inferior good increases. For example, during 1992 the average family in Russia increased its consumption of sugar despite a 4,000-fold increase in the price of sugar, while the price of chocolates increased by about 3,000 times. Here the income effect worked: the general decline in the standard of living of the population led to an increase in the consumption of goods of the lowest category (in this case, sugar).

Real income is the maximum utility that a consumer with a given monetary income can receive. Thus, the nature of the dependence of the quantity demanded on the price of a good is determined by the substitution effect and the income effect.

The substitution effect is the change in quantity demanded due to a change in the relative price of a good while the consumer's real income remains unchanged.

The income effect is the change in quantity demanded due to a change in real income when the relative price of a good remains unchanged.

The total effect of a price change is the change in quantity demanded, which is equal to the sum of the substitution effect and the income effect.

We decompose the total effect into the sum of the substitution effect and the income effect in three steps.

1. When the price of goods X decreases, the budget line will turn counterclockwise around the point of intersection with the coordinate axis (point B in Fig. 1). In this case, the equilibrium set will move from point E¹ to point E², and the volume of consumption of product X will increase from x¹ to x². The overall effect is

2. Draw an imaginary budget line AºBº, tangent to the old indifference curve a¹ and parallel to the new budget line A¹B. The equilibrium set Eº corresponding to the imaginary budget line corresponds to the case when the consumer receives the old utility (the set lies on the old indifference curve) at the new price ratio (the slope of the budget line is determined by this ratio). Thus, for sets E¹ and Eº, the condition from the definition of the substitution effect is satisfied, so the substitution effect is xº - x¹, where xº is the volume of consumption of product X in the set Eº.

3. Sets E² and Eº correspond to the case when real incomes are different (sets lie on different difference curves), and relative prices are the same (parallelism of budget lines), so the income effect is x² - xº.

An illustration of this can be seen in Fig. one.

Consider the question of the direction of the substitution effect and the income effect for the case when both goods are goods.

The substitution effect is always positive. When the price of good X decreases, the imaginary budget line is always flatter than the original budget line, so at point Eº the marginal rate of substitution is less than at point E¹ (Fig. 1). Given that with an increase in the volume of consumption of the product, the marginal rate of substitution decreases (its property), it can be argued that the “imaginary” volume of consumption is greater than the initial volume of consumption.

The income effect is positive for normal goods and negative for inferior goods.

The overall effect is positive if both the substitution effect and the income effect are positive, or when the positive impact of the substitution effect outweighs the negative impact of the income effect. If the negative income effect dominates, then the overall effect is negative, the law of demand is not satisfied, and the good is a Giffen good.

If both products are antigoods, then the substitution effect can be negative (xº< х¹ на рис. 2). Эту ситуацию позволяет объяснить эффект Веблена, когда при понижении относительной цены нормального товара спрос на него сокращается в силу того, что он становится менее «престижным» (рис. 2).

income effect(income effect) this is a change in the quantity demanded for a given product (a change in consumption) caused by a change in purchasing power at constant prices. At the same time, the level of utility increases, and consumption corresponds to a higher indifference curve. The income effect can be positive, negative or neutral. Substitution (replacement) effect (substitution effect)- this is a change in the quantity demanded for a given product (consumption of a product) as a result of a change in its price. The substitution (substitution) effect is always negative: a decrease in the price of one product encourages the consumer to increase its consumption by reducing the consumption of another good. At the same time, the level of utility remains unchanged.

Consider the model of income effect and substitution effect on J. Hicks. Let the original budget line KL has a point of contact E 1 with an indifference curve U 1 , which corresponds to the volume of consumption of goods X in quantity X 1(see figure 7.8).

Figure 7.8 - Substitution effect and income effect

In the event of a price reduction X and a constant cash income, the budget line will take the position KL one . It touches a higher indifference curve U 2 U 2 at point E 2 , which corresponds to the consumption of goods X in volume X 2. Thus, the overall result of a decrease in the price of a good X expressed in an increase in its consumption with X 1 to X 2. Draw an auxiliary budget line K "L’ , parallel to the line KL 1 (i.e. reflecting the new price ratio), so that it touches the indifference curve U 1 U 1 (i.e. would provide the same level of satisfaction). Mark the point of contact E 3 and the corresponding amount of consumption of the goods X 3 .

When moving from E 1 to E 3 the real income of the consumer does not change, it remains on the same indifference curve U 1 U one . So the shift from E 1 to E 3 characterizes replacement effect goods Y relatively cheap goods X. It is equal to the difference X 3 - X one . Hence, income effect amount to X 2 - X 3 . Note that as a result of the income effect, the consumption of both goods at the point E 2 higher than point E 3 .

Similarly, it is considered decomposition of the overall effect and for the case when the price of the good X rises. In our case, the item X considered as normal, the volume of consumption of which increases with income. But if the goods X is an inferior good, then the income effect will be negative and the substitution effect positive. The cumulative result of the effects will depend on the share of the product in the consumer's budget. If a low-quality product occupies a small share in the consumer's budget, then the positive substitution effect offsets the negative income effect in case of price reduction. Otherwise, in the case of a price decrease, the negative income effect overrides the positive substitution effect, and the overall result is a decrease in demand for the good, despite the price decrease.

Thus, for normal goods, the law of demand is always satisfied: when the price of a good decreases, the volume of demand for this product increases, and when the price rises, it decreases. For inferior goods, the law of demand is not always satisfied.

Questions for self-control:

1. What is the essence of the concept of rational economic behavior of the consumer?
2. What are the fundamental differences between the two scientific trends: cardinalism and ordinalism?
3. What is meant by the terms "total utility", "marginal utility"? How is Gossen's first law (the law of diminishing marginal utility) formulated?
4. How do cardinalists describe consumer equilibrium? How is Gossen's second law formulated?
5. How are the axioms of ordinalism formulated?
6. How are indifference curves constructed? What do they reflect? What properties do they have?
7. How is the marginal rate of substitution calculated? What does she characterize?
8. What does the budget line represent? What is the budget constraint equation?
9. How do ordinalists characterize consumer equilibrium?
10. What curves characterize the dynamic equilibrium of the consumer?
11. How is the income effect and the substitution (replacement) effect considered in the theory of consumer behavior?

Basic Tutorial: Course of Economic Theory: Textbook / M. N. Chepurin [and others] - Kirov: ASA - Section 2, Chapter 5 - §§ 3.9.

The individual curve has a different configuration when wage rates rise (Figure 13.7).

Up to the point, the curve shows an increase in the supply of labor with an increase in wages. After the point, it shows a decrease in the supply of labor with a further increase in wages. Thus, the same cause - an increase in wages - leads to both an increase and a reduction in the supply of labor.

This is explained as follows. Up to a point, the worker seeks to replace free time with additional work with an increase in wages. Accordingly, leisure is replaced by the set of goods and services that the worker can purchase with increasing wages. This process has been named substitution effect in the labor market.

Rice. 13.7. Individual labor supply curve

income effect

income effect resists the substitution effect and becomes noticeable when the employee reaches a certain, sufficiently high level of material well-being. When the problems with daily bread are resolved, the attitude towards free time also changes. It ceases to seem like a deduction from wages, but appears as a field for enjoyment and joy, especially since high wages make it possible to enrich and diversify leisure. Therefore, it is logical that a desire arises not only to buy more goods, but also to have more free time. And this can be done only by reducing the supply of labor, buying free time not with cash, but with the money that could be obtained by giving up leisure in favor of additional work. After passing the curve point income effect becomes dominant which is expressed in a reduction in the supply of labor with an increase in wages, but in practice in the desire to transfer the employee to a shorter working day or week, to receive additional days off and holidays.

income effect (Income effect) - the impact on the structure of consumer demand due to a change in his real income caused by a change in the price of the good.

The essence of this effect lies in the fact that when the price of a good decreases, a person can buy more of this good without denying himself the acquisition of other goods. The income effect reflects the impact on the quantity demanded of changes in the real income of the buyer. A fall in the price of one good has an impact, albeit insignificant, on the general price level and makes the consumer relatively richer, his real income, albeit slightly, but growing. He can direct his additional income, received as a result of a decrease in the price of a given good, both to purchase additional units of it, and to increase the consumption of other goods.

For example, when the price of meat is reduced from 200 to 100 rubles. per kg. people on their income of 10,000 rubles. can instead of 50 kg. buy already 100 kg. If he wants to maintain the level of consumption and will continue to buy 50 kg. meat, then he can use the remaining funds to buy other goods, which will make him richer. As a result, demand will increase.

substitution effect

substitution effect (Substitution effect) is a change in the structure of consumer demand as a result of a change in the price of one of the goods included in the consumer bundle.

The essence of this effect boils down to the fact that the consumer, with an increase in the price of one good, is reoriented to another good with similar consumer properties, but with a constant price. In other words, consumers tend to substitute cheaper goods for more expensive ones. As a result, the demand for the original good falls.

For example, coffee and tea are substitute goods. When the price of coffee rises, tea becomes relatively cheaper for consumers and they will substitute it for relatively more expensive coffee. This will increase the demand for tea.

Relationship between the income effect and the substitution effect

The income effect and the substitution effect do not operate in isolation but interact with each other.

For normal goods The income effect and the substitution effect are cumulative, since a decrease in the price of these goods leads to an increase in demand for them.

For example, a consumer, having a given income that does not change, buys tea and coffee in a certain ratio, which are normal goods. In this case, the substitution effect works as follows. A fall in the price of tea will lead to an increase in demand for it. Since the price of coffee has not changed, coffee is now relatively (comparatively) more expensive than tea. A rational consumer replaces relatively expensive coffee with relatively cheap tea, increasing the demand for it. The income effect is manifested in the fact that the decrease in the price of tea made the consumer somewhat richer, i.e. led to an increase in his real income. Since the higher the income level of the population, the higher the demand for normal goods, and the increase in income can be directed both to the purchase of an additional amount of tea and coffee. Therefore, in the same situation (decrease in the price of tea with the price of coffee unchanged), the substitution effect and the income effect lead to an increase in the demand for tea. The income effect and the substitution effect operate in the same direction. For normal goods, income and substitution effects explain the increase in demand when the price falls and the decrease in demand when prices rise. In other words, the law of demand is fulfilled.

For inferior goods the effect of income and substitution effects is determined by their difference.

For example, a consumer, having this income, purchases natural coffee and a coffee drink in a certain ratio, which is a product of the lowest category. In this case, the substitution effect works as follows. A fall in the price of a coffee drink will lead to an increase in the demand for it, since the drink is now a relatively cheap good. Since the price of coffee has not changed, coffee is a relatively (comparatively) expensive commodity. A rational consumer replaces relatively expensive coffee with a relatively cheap coffee drink, increasing demand for it. The income effect is manifested in the fact that a decrease in the price of a coffee drink made the consumer somewhat richer, i.e. led to an increase in his real income. Since the higher the level of income of the population, the lower the volume of demand for lower goods, the increase in the real income of the consumer will be directed to the purchase of an additional amount of coffee. As a result, a decrease in the price of a coffee drink (a lower category product) will lead to a drop in demand for it and an increase in demand for coffee (a product of a higher category). Therefore, in the same situation (a drop in the price of a coffee drink at a constant price of coffee), the substitution effect leads to an increase in the demand for a coffee drink, and the income effect leads to a decrease in demand for it. The income effect and the substitution effect work differently.

5. Income effect and substitution effect

The law of demand is characterized by the fact that the volumes of purchases and goods intended for consumption are inversely related to the price. The very structure of demand directly depends on the operation of the market mechanism and the conditions of sale, which must suit both parties: producers who supply finished products to the market for goods and services and buyers who act in accordance with their needs. Thus, in order to explain the structure and motive of the subject's actions, it is necessary to define the essence of the concepts of "income effect" and "substitution effect".

income effect (Y). By means of this indicator, the degree of dynamics of consumers' incomes is determined and, accordingly, the formation of their demand for a particular product when the general level of market prices changes. So, for example, if you reduce the price of a product by half, this means that with real income that has remained unchanged, you can buy twice as much goods and services. As a result, a wealth effect arises, which operates at the macroeconomic level: if prices fall and the level of income remains the same, then the economic entity feels richer exactly as many times as the amount of goods purchased increases. That is, it turns out that the money is the same, but there are more goods. However, if the volume of consumption must be left at the same level, then a certain amount of other goods can be purchased with the remaining money. This makes the consumer really richer and thereby increases the demand in the market for goods and services. Note that even if the growth of demand stops, with a further decrease in the price, the number of sales of this product will increase, since people with lower incomes will begin to satisfy the needs. Thus, income effect represents a quantitative change in the structure of buyers' demand as a result of the dynamics of their income and solvency.

In its turn substitution effect represents the dependence of consumer demand on the dynamics of the price level without the influence of income structure. At the same time, demand is guided by a system of relative prices. Based on the above example, we can conclude that compared to other goods on the market, those for which prices were reduced became cheaper. This accordingly causes an increase in demand, since consumers will begin to purchase precisely these goods, and not those that have the same purpose, but cost relatively more. This is explained by the desire of the individual to maximize the utility of consuming a given set of goods.

It should be noted that these two concepts (the income effect and the substitution effect) do not exist separately, but act together in the economy. As you know, all goods on the market can be ranked according to the degree of quality: normal, low-quality and Giffen goods. This is when normal goods are consumed, both effects act in the same direction, and the consumer, as income rises, increases the demand for them. Each stage in the decline in the level of market prices creates more and more demand. When prices fall in the inferior market, the income effect works in the opposite direction of the substitution effect. On the one hand, the demand for discounted goods theoretically begins to increase. At the same time, when prices fall and income remains the same, a wealth effect occurs, causing consumers to prefer more expensive goods. For Giffen goods, the income effect outweighs the substitution effect. In other words, when the prices of essential goods begin to rise during a shortage, the demand for them not only remains unchanged, it grows systematically and at a rapid pace. This consumer reaction is explained by the fact that Giffen products essentially satisfy primary needs, and their consumption does not decrease even with an increase in price. For example, if potatoes or bread begin to rise in price, people still continue to buy them, and in a crisis, a rush begins in general.

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