Page 500 - Krugmans Economics for AP Text Book_Neat

What you will learn
in this Module:

• How the income and Module 46
substitution effects explain
the law of demand
• The definition of elasticity, a Income Effects,
measure of responsiveness
to changes in prices or
incomes Substitution Effects,
• The importance of the price
elasticity of demand, which
measures the and Elasticity
responsiveness of the
quantity demanded to
changes in price
• How to calculate the price
elasticity of demand Explaining the Law of Demand

In Section 2 we introduced the demand curve and the law of demand. To this point, we
have accepted that the demand curve has a negative slope. And we have drawn demand
curves that are somewhere in the middle between flat and steep (with a negative slope).
In this module, we present more detail about why demand curves slope downward and
what the slope of the demand curve tells us. We begin with the income and substitution ef-
fects, which explain why the demand curve has a negative slope.

The Substitution Effect
When the price of a good increases, an individual will normally consume less of that good
and more of other goods. Correspondingly, when the price of a good decreases, an indi-
vidual will normally consume more of that good and less of other goods. This explains
why the individual demand curve, which relates an individual’s consumption of a good to
the price of that good, normally slopes downward—that is, it obeys the law of demand.
An alternative way to think about why demand curves slope downward is to focus
on opportunity costs. For simplicity, let’s suppose there are only two goods between
which to choose. When the price of one good decreases, an individual doesn’t have to
give up as many units of the other good in order to buy one more unit of the first good.
That makes it attractive to buy more of the good whose price has gone down. Con-
versely, when the price of one good increases, one must give up more units of the other
The substitution effect of a change in the
good to buy one more unit of the first good, so consuming that good becomes less at-
price of a good is the change in the quantity
tractive and the consumer buys fewer. The change in the quantity demanded as the
of that good demanded as the consumer
substitutes the good that has become good that has become relatively cheaper is substituted for the good that has become
relatively cheaper for the good that has relatively more expensive is known as the substitution effect. When a good absorbs
become relatively more expensive. only a small share of the typical consumer’s income, as with pillow cases and swim

458 section 9 Behind the Demand Curve: Consumer Choice