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AP Economics. Mr. Bernstein Module 46 ( pp 457-460 only): Income and Substitution Effects October 6, 2014. AP Economics Mr. Bernstein. Law of Demand All other things equal, as price increases the quantity demanded falls
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AP Economics Mr. Bernstein Module 46 (pp 457-460 only): Income and Substitution Effects October 6, 2014
AP EconomicsMr. Bernstein Law of Demand • All other things equal, as price increases the quantity demanded falls • So there is an inverse relationship between price and quantity demanded • Plotted on a graph, the law of demand infers a downward sloping demand curve • Why?
AP EconomicsMr. Bernstein The Substitution Effect • The downward sloping demand curve and opportunity costs • Costs: Driving into city = $20; bus ticket = $10 • The opportunity cost of driving = 2 bus tickets • If the price of bus tickets rise to $15, the opportunity cost of driving a car decreases to 1.33 bus tickets • Driving becomes relatively cheaper and the quantity demanded rises
AP EconomicsMr. Bernstein The Substitution Effect • The downward sloping demand curve and opportunity costs • Costs: Driving into city = $20; bus ticket = $10 • The opportunity cost of driving = 2 bus tickets • If the price of bus tickets falls to $5, the opportunity cost of driving a car increases to 4 bus tickets • Driving becomes relatively more expensive and the quantity demanded falls
AP EconomicsMr. Bernstein Note on the Substitution Effect • Substitution Effect causes change in Quantity Demanded for product (i.e., QD decreases as consumers shift to cheaper product • It also causes shift in Demand for substitute product (i.e., Dsub increases)
AP EconomicsMr. Bernstein The Income Effect • Changes in real income • Primarily effects major purchases • New job, higher income = nicer car • Lose job, lose income = less nice car • Income not keeping up with inflation = lower real income = less nice car • Reinforces Substitution Effects • Causes Demand Curve to slope downward