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Substitution and income effects

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1. One of the major concerns of managers and managerial economics is the demand for a company's product. Many factors influence the demand curve for a product, and they all must be included, to some degree, in estimating the demand curve. Define the following factors and discuss how they can affect the demand curve for a product:
â?¢ Inferior versus normal goods
â?¢ Substitution and income effects
â?¢ Derived demand
â?¢ Changes in demand and changes in quantity demanded
Support your answers with examples and reasoning.

2. With regard to profit maximization, managers are concerned about the responsiveness of the quantity demanded for variables such as the price of a product, prices of related products, and consumer incomes. Describe the types of measures and information a manager requires to measure the effects of these variables on costs and revenues. How do these measures assist in profit-maximizing decisions?
Support your answers with examples and reasoning.

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Step One
Inferior versus normal goods:
Inferior goods face a decline in demand when the income increases. In case of normal goods, with an increase in income there is an increase in the demand for those goods. In case of normal goods, if the income of the buyers goes up there is an increase in demand for those goods. The reason why the demand for inferior goods goes down is that these goods can be afforded by people when their income is low but when their income increases; these goods are substituted with costly goods that bring more pleasure. Low cost goods like hamburgers, frozen dinners, and low cost food are examples of inferior goods. Normal goods example is good quality housing.
Step 2
Substitution and income effects
Substitution effect takes place with change in a person's income or changes in prices. When the income of people declines, or the prices of goods goes up the consumer substitutes cheaper goods for costlier ones. For instance, a person uses a cold meal instead of cooking a fresh one. The consumers ...

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Substitution effect & income effect (with graphs)

Managers are very interested in how a consumer makes a choice among alternatives. In this exercise, we ask you to consider the amount of money you spend purchasing gasoline to operate your automobile for a month and any alternatives available to you assuming your net income available to make those purchases. Also assume gasoline prices for your auto rose 100% during one difficult summer as our time period for the purpose of discussion. Explain, then, the following effects in terms of the income effect, or the substitution effect, or both effects:

You drove less and purchased less gasoline.
You ate out less often.
You spent less to maintain your automobile.
You took public transportation more often.
You bought a bicycle.
You did not take a vacation away from home.
You bought fewer clothes and made do with more around the home.

Demonstrate your understanding of the concepts by providing a graph of each effect as a figure.

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