Q2. What is an inferior good? If the price of an inferior good falls what can we say about the quantity consumed? Explain
Definition
Consumer’s demand for goods depend upon the level of income. Inferior goods are defined as goods for which quantity demanded decreases with an increase in consumer’s income and quantity demanded increases with a fall in consumer’s income. This happens when the goods have relatively expensive substitutes available whose demand increases when the consumer becomes richer (with increase in his income). The demand for inferior goods is opposite as that of normal goods for which demand increase with rise in consumer’s income.
Impact of change in income on quantity demanded of inferior goods
The effect of income on demand of inferior goods is illustrated in figure 1. Consider two goods X and Y. Good X is normal while good Y in inferior. The quantity demanded for good X is reflected on X axis (horizontal …show more content…
This is because it is now relatively cheaper than the other good, and the other good is relatively expensive, in terms of how much the cheaper good needs to be given up to consume more of this good. These changes in quantity demanded due to the relative change in prices are known as substitution effect. This effect is reflected through the change in the slope of the final budget line as the price ratio of the two goods has changed.
♣ Income effect: With the decrease in price of the good, the consumer’s real income increases as he can afford more bundles with the same income. This is called income effect.
The result of these effects is that the original budget constraint pivots and BC2 is the final budget constraint. Assuming the preferences are well behaved, the new optimal bundle lies on the new budget line.
Explanation of substitution and income
Definition
Consumer’s demand for goods depend upon the level of income. Inferior goods are defined as goods for which quantity demanded decreases with an increase in consumer’s income and quantity demanded increases with a fall in consumer’s income. This happens when the goods have relatively expensive substitutes available whose demand increases when the consumer becomes richer (with increase in his income). The demand for inferior goods is opposite as that of normal goods for which demand increase with rise in consumer’s income.
Impact of change in income on quantity demanded of inferior goods
The effect of income on demand of inferior goods is illustrated in figure 1. Consider two goods X and Y. Good X is normal while good Y in inferior. The quantity demanded for good X is reflected on X axis (horizontal …show more content…
This is because it is now relatively cheaper than the other good, and the other good is relatively expensive, in terms of how much the cheaper good needs to be given up to consume more of this good. These changes in quantity demanded due to the relative change in prices are known as substitution effect. This effect is reflected through the change in the slope of the final budget line as the price ratio of the two goods has changed.
♣ Income effect: With the decrease in price of the good, the consumer’s real income increases as he can afford more bundles with the same income. This is called income effect.
The result of these effects is that the original budget constraint pivots and BC2 is the final budget constraint. Assuming the preferences are well behaved, the new optimal bundle lies on the new budget line.
Explanation of substitution and income