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AP Economics. Mr. Bernstein Module 46 ( pp 457-460 only): Income and Substitution Effects October 7, 2013. AP Economics Mr. Bernstein. Law of Demand All other things equal, as price increases the quantity demanded falls

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    ap economics

    AP Economics

    Mr. Bernstein

    Module 46 (pp 457-460 only):

    Income and Substitution Effects

    October 7, 2013

    ap economics mr bernstein
    AP EconomicsMr. Bernstein

    Law of Demand

    • All other things equal, as price increases the quantity demanded falls
    • So there is an inverse relationship between price and quantity demanded
    • Plotted on a graph, the law of demand infers a downward sloping demand curve
    • Why?
    ap economics mr bernstein1
    AP EconomicsMr. Bernstein

    The Substitution Effect

    • The downward sloping demand curve and opportunity costs
    • Costs: Driving into city = $20; bus ticket = $10
    • The opportunity cost of driving = 2 bus tickets
    • If the price of bus tickets rise to $15, the opportunity cost of driving a car decreases to 1.33 bus tickets
    • Driving becomes relatively cheaper and the quantity demanded rises
    ap economics mr bernstein2
    AP EconomicsMr. Bernstein

    The Substitution Effect

    • The downward sloping demand curve and opportunity costs
    • Costs: Driving into city = $20; bus ticket = $10
    • The opportunity cost of driving = 2 bus tickets
    • If the price of bus tickets falls to $5, the opportunity cost of driving a car increases to 4 bus tickets
    • Driving becomes relatively more expensive and the quantity demanded falls
    ap economics mr bernstein3
    AP EconomicsMr. Bernstein

    The Income Effect

    • Changes in real income
    • Primarily effects major purchases
    • New job, higher income = nicer car
    • Lose job, lose income = less nice car
    • Income not keeping up with inflation = lower real income = less nice car
    • Reinforces Substitution Effects
    • Causes Demand Curve to slope downward