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KEMP-ROTH ACT: Officially titled the Economic Recovery Tax Act of 1981, this was a cornerstone of economic policy under President Reagan. The three components of this act were: (1) a decrease in individual income taxes, phased in over three years, (2) a decrease in business taxes, primarily through changes in capital depreciation, and (3) the indexing of taxes to inflation, which was implemented in 1985. This act was intended to address the stagflation problems of high unemployment and high inflation that existed during that 1970s and to provide greater incentives for investment. A primary theoretical justification is found in the Laffer curve relation between tax rates and total tax collections.

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INCOME CHANGE, UTILITY ANALYSIS:

A disruption of consumer equilibrium identified with utility analysis caused by changes in the buyers' income, which results in a change in the quantities of the goods consumed. The change in buyers' income alters the income constraint and forces a reevaluation of the rule of consumer equilibrium.
Utility analysis can be used to illustrate how a change in income alters the consumer equilibrium combination of goods consumed. With more or less income, a consumer is able to purchase larger or smaller quantities of the goods. This particular utility analysis of consumer equilibrium provides insight into the buyers' income demand determinant.

A Review of Consumer Equilibrium

Pretzels and Sundaes
Consumer Equilibrium
First, a review of consumer equilibrium is in order.
  • Two Goods: The table at the right presents utility information for Duncan Thurly, a snack-hunger consumer who is purchasing two goods, Max Mulroney's Pretzel-on-a-Stick and Hot Momma Fudge Bananarama Ice Cream Sundae.

    The left half of the table summarizes the utility numbers for Duncan's pretzel consumption. The utility story for Duncan's hot fudge sundae consumption is in the right half of the table.


  • Income and Prices: At the moment, Duncan has only $20 of income available for his initial choice between pretzels and hot fudge sundaes. The price per pretzel is $2 and the price of each hot fudge sundae is $4.

  • The Choice: Under these circumstances, Duncan selects 4 pretzels and 3 hot fudge sundaes, spending $8 on pretzels and $12 on hot fudge sundaes.

  • Consumer Equilibrium: This combination satisfies the rule of consumer equilibrium and equates the marginal utility-price ratio for each good. The marginal utility of the last pretzel is 6 utils, giving a marginal utility-price ratio of 3 utils per dollar. The marginal utility of the last hot fudge sundae is 12 utils, also resulting in a marginal utility-price ratio of 3 utils per dollar. Consumer equilibrium is achieved.

  • Utility Maximization: And with consumer equilibrium, utility is maximized at a total of 84 utils. The purchase of 4 pretzels generates 36 utils of satisfaction and the consumption of 3 hot fudge sundaes adds another 48 utils. No other combination of pretzels and hot fudge sundaes that can be purchased with $20 of income generates a greater level of utility.

An Income Change

The key point of analysis is to pose the question: What occurs if Duncan has a change in income? In particular, suppose that Duncan has a boost in his snack budget from $20 to $26. How might the consumer equilibrium quantities of pretzels and hot fudge sundaes change?

To answer this question, the original consumer equilibrium must be reevaluated. If Duncan continues to consume 3 sundaes and 4 pretzels, he spends only $20, but his new budget constraint is now $26. Duncan has $6 extra dollars to spend. Given that sundaes are $4 and pretzels are $2, why not consume one more of each? Doing so uses up the extra $6. Click the [Income Change] button in the adjoining exhibit to highlight this new option.

Pretzels and Sundaes
Consumer Equilibrium

  • All Income Spent: The combination of 5 pretzels and 4 hot fudge sundaes seems to be an appropriate choice of the two goods. With this new income, Duncan spends $10 on pretzels and $16 on hot fudge sundaes, which now exhausts the larger amount of income.

  • Consumer Equilibrium: As it turns out, this new combination also satisfies the rule of consumer equilibrium and equates the marginal utility-price ratio for each good. The marginal utility of the last pretzel is 4 utils, giving a marginal utility-price ratio of 2 utils per dollar. The marginal utility of the last hot fudge sundae is 8 utils, also resulting in a marginal utility-price ratio of 2 utils per dollar. Consumer equilibrium is achieved.

  • Utility Maximization: And with this new consumer equilibrium, utility is now maximized at a total of 96 utils. The purchase of 5 pretzels generates 40 utils of satisfaction and the consumption of 4 hot fudge sundaes adds another 56 utils. No other combination of pretzels and hot fudge sundaes purchased with $26 of income generates a greater level of utility.
It looks as though the option of buying one more of each good generates the new consumer equilibrium. The increase in income results in an increase in the quantity of the goods consumed. This means that both goods, in this example, are normal goods.

<= INCENTIVEINCOME EARNED BUT NOT RECEIVED =>


Recommended Citation:

INCOME CHANGE, UTILITY ANALYSIS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: May 25, 2018].


Check Out These Related Terms...

     | price change, utility analysis | preferences change, utility analysis |


Or For A Little Background...

     | utility analysis | consumer equilibrium | buyers' income, demand determinant | rule of consumer equilibrium | marginal utility-price ratio | utility maximization | constrained utility maximization | law of diminishing marginal utility | marginal utility | normal good |


And For Further Study...

     | utility | total utility | consumer demand theory | utility measurement | cardinal utility | ordinal utility | util | utilitarianism | total utility curve | marginal utility curve | diamond-water paradox |


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