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By the end of this section, you will be able to:

  • Explain how income, prices, and preferences affect consumer choices
  • Contrast the substitution effect and the income effect
  • Utilize concepts of demand to analyze consumer choices
  • Apply utility-maximizing choices to governments and businesses

Just as utility and marginal utility can be used to discuss making consumer choices along a budget constraint, these ideas can also be used to think about how consumer choices change when the budget constraint shifts in response to changes in income or price. Indeed, because the budget constraint framework can be used to analyze how quantities demanded change because of price movements, the budget constraint model can illustrate the underlying logic behind demand curves.

How changes in income affect consumer choices

Let’s begin with a concrete example illustrating how changes in income level affect consumer choices. [link] shows a budget constraint    that represents Kimberly’s choice between concert tickets at $50 each and getting away overnight to a bed-and-breakfast for $200 per night. Kimberly has $1,000 per year to spend between these two choices. After thinking about her total utility and marginal utility and applying the decision rule that the ratio of the marginal utilities to the prices should be equal between the two products, Kimberly chooses point M, with eight concerts and three overnight getaways as her utility-maximizing choice.

How a change in income affects consumption choices

The graph's various points represent which good is viewed as inferior. The first solid downward sloping line represents the original budget constraint. The second budget constraint represents a different set of options based on the consumer having more money to spend on both items.
The utility-maximizing choice on the original budget constraint is M. The dashed horizontal and vertical lines extending through point M allow you to see at a glance whether the quantity consumed of goods on the new budget constraint is higher or lower than on the original budget constraint. On the new budget constraint, a choice like N will be made if both goods are normal goods. If overnight stays is an inferior good, a choice like P will be made. If concert tickets are an inferior good, a choice like Q will be made.

Now, assume that the income Kimberly has to spend on these two items rises to $2,000 per year, causing her budget constraint to shift out to the right. How does this rise in income alter her utility-maximizing choice? Kimberly will again consider the utility and marginal utility that she receives from concert tickets and overnight getaways and seek her utility-maximizing choice on the new budget line. But how will her new choice relate to her original choice?

The possible choices along the new budget constraint can be divided into three groups, which are divided up by the dashed horizontal and vertical lines that pass through the original choice M in the figure. All choices on the upper left of the new budget constraint that are to the left of the vertical dashed line, like choice P with two overnight stays and 32 concert tickets, involve less of the good on the horizontal axis but much more of the good on the vertical axis. All choices to the right of the vertical dashed line and above the horizontal dashed line—like choice N with five overnight getaways and 20 concert tickets—have more consumption of both goods. Finally, all choices that are to the right of the vertical dashed line but below the horizontal dashed line, like choice Q with four concerts and nine overnight getaways, involve less of the good on the vertical axis but much more of the good on the horizontal axis.

Questions & Answers

how is the graph works?I don't fully understand
Rezat Reply
multiple choice question
Aster Reply
explain perfect market
Lindiwe Reply
In economics, a perfect market refers to a theoretical construct where all participants have perfect information, goods are homogenous, there are no barriers to entry or exit, and prices are determined solely by supply and demand. It's an idealized model used for analysis,
Ezea
What is ceteris paribus?
Shukri Reply
other things being equal
AI-Robot
When MP₁ becomes negative, TP start to decline. Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of lab
Kelo
Extuples Suppose that the short-run production function of certain cut-flower firm is given by: Q=4KL-0.6K2 - 0.112 • Where is quantity of cut flower produced, I is labour input and K is fixed capital input (K-5). Determine the average product of labour (APL) and marginal product of labour (MPL)
Kelo
yes,thank you
Shukri
Can I ask you other question?
Shukri
what is monopoly mean?
Habtamu Reply
What is different between quantity demand and demand?
Shukri Reply
Quantity demanded refers to the specific amount of a good or service that consumers are willing and able to purchase at a give price and within a specific time period. Demand, on the other hand, is a broader concept that encompasses the entire relationship between price and quantity demanded
Ezea
ok
Shukri
how do you save a country economic situation when it's falling apart
Lilia Reply
what is the difference between economic growth and development
Fiker Reply
Economic growth as an increase in the production and consumption of goods and services within an economy.but Economic development as a broader concept that encompasses not only economic growth but also social & human well being.
Shukri
production function means
Jabir
What do you think is more important to focus on when considering inequality ?
Abdisa Reply
any question about economics?
Awais Reply
sir...I just want to ask one question... Define the term contract curve? if you are free please help me to find this answer 🙏
Asui
it is a curve that we get after connecting the pareto optimal combinations of two consumers after their mutually beneficial trade offs
Awais
thank you so much 👍 sir
Asui
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities, where neither p
Cornelius
In economics, the contract curve refers to the set of points in an Edgeworth box diagram where both parties involved in a trade cannot be made better off without making one of them worse off. It represents the Pareto efficient allocations of goods between two individuals or entities,
Cornelius
Suppose a consumer consuming two commodities X and Y has The following utility function u=X0.4 Y0.6. If the price of the X and Y are 2 and 3 respectively and income Constraint is birr 50. A,Calculate quantities of x and y which maximize utility. B,Calculate value of Lagrange multiplier. C,Calculate quantities of X and Y consumed with a given price. D,alculate optimum level of output .
Feyisa Reply
Answer
Feyisa
c
Jabir
the market for lemon has 10 potential consumers, each having an individual demand curve p=101-10Qi, where p is price in dollar's per cup and Qi is the number of cups demanded per week by the i th consumer.Find the market demand curve using algebra. Draw an individual demand curve and the market dema
Gsbwnw Reply
suppose the production function is given by ( L, K)=L¼K¾.assuming capital is fixed find APL and MPL. consider the following short run production function:Q=6L²-0.4L³ a) find the value of L that maximizes output b)find the value of L that maximizes marginal product
Abdureman
types of unemployment
Yomi Reply
What is the difference between perfect competition and monopolistic competition?
Mohammed
what are y=b+mx
Deva Reply
The equation y = b + mx represents a linear equation in slope-intercept form, where y is the dependent variable, x is the independent variable, m is the slope, and b is the y-intercept. The slope-intercept form of a linear equation is commonly written as y = mx + b, where m represents the slope of
Steven
Consider the following Total Revenue (TR) and Total Cost (TC) functions for a firm operating in a perfect competition market: TR = 6Q and TC = Q3 – 2Q2 + 50Q + 25 Determine the profit maximizing or loss minimizing equilibrium level of output. Compute the level of
Abdulwab Reply

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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