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Substitution and income effects - Assignment Example

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Substitution and income effects Grade Course (25th, Oct. 2012) Substitution and income effects Whenever, the price of a commodity utilized by a consumer changes, other subsequent changes occur. These changes affect the income of the consumer and his/her ability to purchase other commodities (McEachern, 2012)…
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Download file to see previous pages Therefore, an increase in the price of gasoline has various effects. The owner of the vehicle can opt to take several measures in order to remain at the same level of satisfaction (Hall & Lieberman, 2008). Considering that it is only the price of gasoline that have changed, yet the income of the consumer remains constant, the following decisions will have different income and substitution effects: You drove less and purchased less gasoline When a consumer decides to drive less and purchase less gasoline, he/she will be able to save some income. The income saved from the reduction in the gasoline purchased can make up for the budget reduction that would have occurred as a result of increased gasoline prices (Landsburg, 2011). However, the satisfaction obtained by the consumer is likely to change. This is because, the consumer can no longer travel to far off distances where he/she used to go before. This could limit the satisfaction he obtains from the travel and adventure (Hall & Lieberman, 2008). Additionally, the reduction in the quantity of gasoline purchased limits the extent to which the basket of the consumer can be filled, since some cheaper commodities that make up his/her basket could be found some distance away. Therefore, although reducing the quantity of gasoline purchased and the consequent distance travelled can maintain the consumers purchasing power, it is likely to reduce his/her satisfaction (McEachern, 2012). You ate out less often The effects of reducing what the customer eats, is not any different. Eating out less often has the substitution effect of conserving some resources that could have been used for food, to make up for the gap created by the increased gasoline price. This is meant to maintain the customer at the same level of consumption for gasoline units, despite the change in its prices (). However, even though such a move can keep the consumer at the same levels of gasoline consumption, he/she has already lost out in the quantity of food and drinks consumed. This has the effect of reducing the satisfaction of the customer, derived from eating several times in a day (Landsburg, 2011). In making such a decision, the preference and utility derived by the consumer from eating certain units of foodstuff in a day will play a greater role (Hall & Lieberman, 2008). The consumer will make his/her shopping basket based on the preference and the utility he/she derives from them. Thus, although reducing the quantity of foodstuff consumed can maintain the purchasing power of the consumer, his/her situation could be worse off in terms of satisfaction derived from foodstuff consumption (McEachern, 2012). You spent less to maintain your automobile Where the consumer decides to reduce the money spent in maintaining the automobile to mitigate the effects of increased fuel prices, the decision can maintain his purchasing power in the short run. However, this can be detrimental in the long run, since the automobile might end up breaking down, causing more resources to be used in its repair, than would have been used in its maintenance (Hall & Lieberman, 2008). Therefore, reducing the resources used in automobile maintenance can help the consumer remain at the same consumption level as before. However, this is not sustainable since lack of maintenance worsens the condition of the automobile. This is likely to ...Download file to see next pagesRead More
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