Economics, 3rd Edition

CASE STUDY

(Continued )

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116  PART 2  SUPPLY AND DEMAND: HOW MARKETS WORK

How Changes in Income Affect the Consumer’s Choices

Suppose that income increases. We know that if income increases there is a parallel shift of the budget 

constraint with the same slope of the initial budget line because the relative price of the two goods has 

not changed.

The increase in income means there is an incentive for the consumer to reallocate his spending 

decisions to increase utility and choose a better combination of cola and pizza. In other words, the con-

sumer can now reach a higher indifference curve as shown in Figure 5.12. The consumer reallocates 

income until he reaches a new optimum labelled ‘new optimum’.

Notice that in Figure 5.12 the consumer chooses to consume more cola and more pizza. Although 

the logic of the model does not require increased consumption of both goods in response to increased 

income, this situation is the most common one. Remember, if a consumer wants more of a good when 

his income rises, economists call it a normal good. The indifference curves in Figure 5.12 are drawn under 

the assumption that both cola and pizza are normal goods.

Figure 5.13 shows an example in which an increase in income induces the consumer to buy more pizza 

but less cola. If a consumer buys less of a good when his income rises, economists call it an inferior good. 

Figure 5.13 is drawn under the assumption that pizza is a normal good and cola is an inferior good.

shirts (I probably did not need one shirt) and if I was being asked to hand over 

€60 for the item regardless 

of how many shirts, I may not have made the decision to spend that much money. If I was never going to 

spend it then it is not a saving. Many consumers, however, do tell their friends that they ‘saved’ lots as a 

result of their trip, despite these facts. Psychologists call it confirmation bias.

There is also research which shows that far from being rational in our decision making when shopping, 

we can be deeply irrational. Our brains react differently to information we see when we are shopping and 

retailers know this. On the one hand we are primed when we go shopping. Psychologists have shown 

that when humans are given information which creates an association they are more likely to behave in 

ways which confirm the association. If the brain is primed to look for bargains or offers we are more likely 

to make a purchase decision when confronted with information which seems to represent a ‘bargain’. 

If prices are lower than anticipated then the decision making part of the brain registers this and we are 

more likely to make the purchase as a result. Equally, if prices are much higher than anticipated a different 

part of the brain associated with registering pain is activated and we avoid the purchase.

Overall, therefore, whilst our model of consumer behaviour provides some insights, as with any model 

it is a representation of reality and not reality itself. There is now a great deal of research being conduc-

ted which is shedding more light on consumer behaviour which casts doubt on just how rational we are 

capable of being.

Many stores provide 

information on their receipt 

or online order form telling 

consumers how much they 

have ‘saved’ as a result of 

their purchase decisions

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CHAPTER 5  BACKGROUND TO DEMAND: THE THEORY OF CONSUMER CHOICE  117

Although most goods are normal goods, there are some inferior goods in the world. One example is 

bus rides. High-income consumers are more likely to own cars and less likely to ride the bus than low-in-

come consumers. Bus rides, therefore, are an inferior good.