Page 463 - The Principle of Economics

CHAPTER 21 THE THEORY OF CONSUMER CHOICE 473
New budget constraint
New optimum
1. An increase in income shifts the budget constraint outward . . .
Initial optimum
Initial budget constraint
I2
I 1
Quantity of Pepsi
Figure 21-7
AN INCREASE IN INCOME.
When the consumer’s income rises, the budget constraint shifts out. If both goods are normal goods, the consumer responds to the increase in income by buying more of both of them. Here the consumer buys more pizza and more Pepsi.
3. . . . and Pepsi consumption.
0
Quantity of Pizza
2. . . . raising pizza consumption . . .
that income increases. With higher income, the consumer can afford more of both goods. The increase in income, therefore, shifts the budget constraint outward, as in Figure 21-7. Because the relative price of the two goods has not changed, the slope of the new budget constraint is the same as the slope of the initial budget constraint. That is, an increase in income leads to a parallel shift in the budget constraint.
The expanded budget constraint allows the consumer to choose a better com- bination of Pepsi and pizza. In other words, the consumer can now reach a higher indifference curve. Given the shift in the budget constraint and the consumer’s preferences as represented by his indifference curves, the consumer’s optimum moves from the point labeled “initial optimum” to the point labeled “new opti- mum.”
Notice that, in Figure 21-7, the consumer chooses to consume more Pepsi and more pizza. Although the logic of the model does not require increased consump- tion of both goods in response to increased income, this situation is the most com- mon one. As you may recall from Chapter 4, if a consumer wants more of a good when his income rises, economists call it a normal good. The indifference curves in Figure 21-7 are drawn under the assumption that both Pepsi and pizza are nor- mal goods.
Figure 21-8 shows an example in which an increase in income induces the con- sumer to buy more pizza but less Pepsi. If a consumer buys less of a good when his income rises, economists call it an inferior good. Figure 21-8 is drawn under the assumption that pizza is a normal good and Pepsi is an inferior good.
Although most goods are normal goods, there are some inferior goods in the world. One example is bus rides. High-income consumers are more likely to own cars and less likely to ride the bus than low-income consumers. Bus rides, there- fore, are an inferior good.
normal good
a good for which an increase in income raises the quantity demanded
inferior good
a good for which an increase in income reduces the quantity demanded