Substitution and Income Effects

Substitution and Income Effects

Marcus Marshall

BUS640: Managerial Economics

Instructor Charles Fanning

June 2, 2011

Substitution and Income Effects

For managers in almost every market or industry, if they have consumers buying products from them they must realize that consumers will have options. The way the consumers decide on what option works the best for them or what isn’t a good fit is determined by a number of factors. This could be from a consumer’s personal taste, how much they are willing to spend, if the product is popular in their part of the country and I could literally go on and on. Basically there are a number of factors that go into consumers buying products. With my current job, I do a lot of driving in the field visiting different hospital and physician offices. The cost of gas for me each month has been averaging around $480 per month when filling up twice a week. In order to increase my business at the hospital and recruit more physicians, I have no other choice than to hit the road daily. The only alternative for me would be to get a promotion where I’m not driving as much daily because if my alternative in this current role is to cut back on my driving then I may be out of a job completely. With gas prices around $4 a gallon nationwide, it would be very hard to imagine if price of gas rose 100% during one difficult summer and was around $8 per gallon. Throughout this paper there will be specific situations that I will explain the effects in terms of the income effect, the substitution effect or both effects. The substitution effect is the change in the consumption of a good that would result if the consumer remained on the same indifference curve after the price of the good changed (Thomas, Maurice, 2011, pg. 187). In comparison the income effect is the change in the consumption of a good resulting strictly from a change in purchasing power after the price of a good changes (Thomas, Maurice, 2011, pg. 188).

In the first...