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<h2>How Changes in Income and Prices Affect Consumption Choices</h2>
<p>Just as utility and marginal utility can be used to discuss making consumer choices along a budget constraint, these ideas can also be used to think about how consumer choices change when the budget constraint shifts in response to changes in income or price. Indeed, because the budget constraint framework can be used to analyze how quantities demanded change because of price movements, the budget constraint model can illustrate the underlying logic behind demand curves.</p>
<h2>How Changes in Income Affect Consumer Choices</h2>
<p>Let’s begin with a concrete example illustrating how changes in income level affect consumer choices. <a href="#CNX_Econ_C06_002">This figure</a> shows a <strong>budget constraint</strong> that represents Kimberly’s choice between concert tickets at $50 each and getting away overnight to a bed-and-breakfast for $200 per night. Kimberly has $1,000 per year to spend between these two choices. After thinking about her total utility and marginal utility and applying the decision rule that the ratio of the marginal utilities to the prices should be equal between the two products, Kimberly chooses point M, with eight concerts and three overnight getaways as her utility-maximizing choice.</p>
<div class="fig_container" id="CNX_Econ_C06_002">
<p data-type="title"><strong>How a Change in Income Affects Consumption Choices</strong></p>
<div class="wp-caption alignnone" style="width: 390px"><img alt="The graph's various points represent which good is viewed as inferior. The first solid downward sloping line represents the original budget constraint. The second budget constraint represents a different set of options based on the consumer having more money to spend on both items." height="303" src="https://data.ulearngo.com/assets/e0a00499-6c0b-42bd-879a-a66cb5a28346" width="390"/><p class="wp-caption-text">The utility-maximizing choice on the original budget constraint is M. The dashed horizontal and vertical lines extending through point M allow you to see at a glance whether the quantity consumed of goods on the new budget constraint is higher or lower than on the original budget constraint. On the new budget constraint, a choice like N will be made if both goods are normal goods. If overnight stays is an inferior good, a choice like P will be made. If concert tickets are an inferior good, a choice like Q will be made.</p></div>
</div>
<p>Now, assume that the income Kimberly has to spend on these two items rises to $2,000 per year, causing her budget constraint to shift out to the right. How does this rise in income alter her utility-maximizing choice? Kimberly will again consider the utility and marginal utility that she receives from concert tickets and overnight getaways and seek her <strong>utility-maximizing choice</strong> on the new budget line. But how will her new choice relate to her original choice?</p>
<p>The possible choices along the new budget constraint can be divided into three groups, which are divided up by the dashed horizontal and vertical lines that pass through the original choice M in the figure. All choices on the upper left of the new budget constraint that are to the left of the vertical dashed line, like choice P with two overnight stays and 32 concert tickets, involve less of the good on the horizontal axis but much more of the good on the vertical axis. All choices to the right of the vertical dashed line and above the horizontal dashed line—like choice N with five overnight getaways and 20 concert tickets—have more consumption of both goods. Finally, all choices that are to the right of the vertical dashed line but below the horizontal dashed line, like choice Q with four concerts and nine overnight getaways, involve less of the good on the vertical axis but much more of the good on the horizontal axis.</p>
<p>All of these choices are theoretically possible, depending on Kimberly’s personal preferences as expressed through the total and marginal utility she would receive from consuming these two goods. When income rises, the most common reaction is to purchase more of both goods, like choice N, which is to the upper right relative to Kimberly’s original choice M, although exactly how much more of each good will vary according to personal taste. Conversely, when income falls, the most typical reaction is to purchase less of both goods. As defined in the tutorial on <a data-page="11" href="https://app.ulearngo.com/tutorials/demand-and-supply/">Demand and Supply</a> and again in the tutorial on <a data-page="21" href="https://app.ulearngo.com/tutorials/elasticity/">Elasticity</a>, goods and services are called <strong>normal goods</strong> when a rise in income leads to a rise in the quantity consumed of that good and a fall in income leads to a fall in quantity consumed.</p>
<p>However, depending on Kimberly’s preferences, a rise in income could cause consumption of one good to increase while consumption of the other good declines. A choice like P means that a rise in income caused her quantity consumed of overnight stays to decline, while a choice like Q would mean that a rise in income caused her quantity of concerts to decline. Goods where demand declines as income rises (or conversely, where the demand rises as income falls) are called “inferior goods.” An <strong>inferior good</strong> occurs when people trim back on a good as income rises, because they can now afford the more expensive choices that they prefer. For example, a higher-income household might eat fewer hamburgers or be less likely to buy a used car, and instead eat more steak and buy a new car.</p>

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How Changes in Income Affect Consumer Choices

Economics studies social behavior guiding the allocation of scarce resources to meet the unlimited needs and desires of the individual members of a given society, and for the production of goods and services, growth of production and welfare over time, and a great variety of other complex issues of vital concern to society. 

Economics

Learn how to make optimal consumer choices by understanding concepts such as total utility, marginal utility, demand curves, and intertemporal choices, as well as the impact of changes in income and prices on consumer decision-making in various settings such as government, business, and financial markets.


How Changes in Income Affect Consumer Choices

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