Students sometimes mistakenly think that the substitution effect and the income effect are part of a sequential process that changes quantity demanded when price changes. First, one effect occurs, and then the other occurs. In reality, the substitution effect and income effect work simultaneously. The following analogy may help clarify this point. Picture a boat that is adrift on the ocean with the tide moving it directly south. Also suppose that the wind is from the north such that it, too, is pushing the boat directly south. The two forces, the tide and the wind, work simultaneously. We would need to measure their strengths to sort out their relative importance. But it is evident that, over some time period, the boat will drift farther to the south than if only the tide or the wind was singularly at work. The substitution effect of a price change is analogous to the tide and the income effect is analogous to the wind. For a normal good, the two effects increase quantity demanded when price falls, and decrease quantity demanded when price increases. The substitution effect (the tide) works through a change in the relative price of the good; the income effect (the wind) works through the change in the real income that results from the price change. The two effects work simultaneously and together to change quantity demanded (move the boat) when price changes.

21.2 Diminishing marginal utility button

Newspaper dispensing devices and soft drink vending machines are similar in their basic operations. Both enable consumers to buy a product by inserting coins. But there is an important difference in the two devices. The newspaper dispenser opens to the full stack of papers and seemingly "trusts" the customer to take only a single copy, whereas the vending machine displays no such "trust," requiring the consumer to buy one can at a time. Why the difference? The idea of diminishing marginal utility is key to solving this puzzle. Most consumers take only single copies from the newspaper box because the marginal utility of a second newspaper is nearly zero. They could grab a few extra papers and try to sell them on the street, but the revenue obtained would be small relative to their time and effort. So, in selling their product newspaper publishers rely on "zero marginal utility of the second unit," not on "consumer honesty." Also, newspapers have little "shelf life"; they are obsolete the next day. In contrast, soft drink sellers do not allow buyers to make a single payment and then take as many cans as they want. If they did, consumers would clean out the machine because the marginal utility of successive cans of soda diminishes slowly and buyers could take extra sodas and consume them later. Soft drink firms thus vend their products on a pay-per-can basis. In summary, newspaper publishers and soft drink firms use alternative vending techniques because of the highly different rates of decline in marginal utility for their products. The newspaper seller uses inexpensive dispensers that open to the full stack of papers. The soft drink seller uses expensive vending machines that limit the consumer to a single can at a time. Each vending technique is optimal under the particular economic circumstance.

Photograph courtesy of: (c)Nance Trueworthy;

Photograph courtesy of: (c)Nance Trueworthy;

21.3 Indifference curves button

The familiar topographical map may help you understand the idea of indifference curves and indifference maps. Each line on a topographical map represents a particular elevation above sea level, say, 4,000 feet. Similarly, an indifference curve represents a particular level of total utility. When you move from one point on a specific elevation line to another, the elevation remains the same. So it is with an indifference curve. A move from one position to another on the curve leaves total utility unchanged. Neither elevation lines nor indifference curves can intersect. If they did, the meaning of each line or curve would be violated. An elevation line is "an equal elevation line"; an indifference curve is "an equal total utility curve." Like the topographical map, an indifference map contains not just one line, but a series of lines. That is, the topographical map may have elevation lines representing successive higher elevations of 1,000, 2,000, 3,000, 4,000, and 5,000 feet. Similarly, the indifference curves on the indifference map represent successive higher levels of total utility. The climber whose goal is to maximize elevation wants to get to the highest possible elevation line; the consumer desiring to maximize total utility wants to get to the highest possible indifference curve. Finally, both topographical maps and indifference maps show only a few of the many such lines that could be drawn. The topographical map, for example, leaves out the elevation lines for 1,001, 1,002, 1,003 feet, and so on. The indifference map leaves out all the indifference curves that could be drawn between those illustrated.

Photograph courtesy of: (c)Nance Trueworthy;