CHAPTER • Individual and Market Demand 121 Section 3.1—namely, that indifference curves are convex Thus, with the convex indifference curves shown in the figure, the point that maximizes satisfaction on the new imaginary budget line parallel to RT must lie below and to the right of the original point of tangency Income Effect Now let’s consider the income effect: the change in food consumption brought about by the increase in purchasing power, with relative prices held constant In Figure 4.6, we can see the income effect by moving from the imaginary budget line that passes through point D to the parallel budget line, RT, which passes through B The consumer chooses market basket B on indifference curve U2 (because the lower price of food has increased her level of utility) The increase in food consumption from OE to OF2 is the measure of the income effect, which is positive, because food is a normal good (consumers will buy more of it as their incomes increase) Because it reflects a movement from one indifference curve to another, the income effect measures the change in the consumer’s purchasing power We have seen in Figure 4.6 that the total effect of a change in price is given theoretically by the sum of the substitution effect and the income effect: • income effect Change in consumption of a good resulting from an increase in purchasing power, with relative prices held constant Total Effect (F1F2) = Substitution Effect (F1E) + Income Effect (EF2) Recall that the direction of the substitution effect is always the same: A decline in price leads to an increase in consumption of the good However, the income effect can move demand in either direction, depending on whether the good is normal or inferior A good is inferior when the income effect is negative: As income rises, consumption falls Figure 4.7 shows income and substitution effects for an inferior good The negative income effect is measured by line segment EF2 Even with Clothing (units per month) R • inferior good A good that has a negative income effect F IGURE 4.7 INCOME AND SUBSTITUTION EFFECTS: INFERIOR GOOD A B U2 D U1 O F1 F2 Substitution Effect Total Effect E S Income Effect Food T (units per month) The consumer is initially at A on budget line RS With a decrease in the price of food, the consumer moves to B The resulting change in food purchased can be broken down into a substitution effect, F1E (associated with a move from A to D), and an income effect, EF2 (associated with a move from D to B) In this case, food is an inferior good because the income effect is negative However, because the substitution effect exceeds the income effect, the decrease in the price of food leads to an increase in the quantity of food demanded