Chapter 9: Problem 10

Most retailers are blaming the cconomy for their poor sales, but one store chain that sells used name-brand children's clothes, toys, and furniture is boldly declaring that an economic downturn can actually be a boon for its business. Last year, the company took in $\$ 20$ million in sales, up $5 \%$ from the previous year. a. According to the news clip, is used clothing a normal good or an inferior good? If the price of used clothing falls and income remains the same, explain how the quantity of used clothing bought changes. b. Describe the substitution effect and the income effect that occur.

Short Answer

Expert verified

Used clothing is an inferior good. A fall in its price with unchanged income increases quantity demanded. Substitution and income effects both lead to higher consumption of used clothing.

Step by step solution

Identify the type of good

To determine if used clothing is a normal good or an inferior good, look at sales trends in relation to economic conditions. The news clip states that sales of used children's clothes increased by 5% during an economic downturn. This suggests that used clothing is an inferior good because demand for it increases when income drops.

Impact of price change on quantity demanded

If the price of used clothing falls while income remains the same, the law of demand dictates that the quantity of used clothing demanded would increase. This is because a lower price makes the product more affordable, hence more people are likely to buy it.

Describe the substitution effect

The substitution effect occurs when consumers choose to purchase more of a cheaper substitute good (used clothing) when other goods (new clothing) remain at higher prices. A fall in the price of used clothing makes it more attractive compared to new clothing, encouraging consumers to buy more of it.

Describe the income effect

The income effect describes how a price change impacts consumer purchasing power. When the price of used clothing falls, the real income of consumers effectively increases because they can buy more with the same amount of money. Even though their actual income hasn't changed, the reduction in price allows them to afford more used clothing.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Substitution Effect

The substitution effect explains how consumers react to changes in the relative price of goods. Specifically, when the price of a good falls, it becomes cheaper compared to other goods. This encourages consumers to substitute the cheaper good for more expensive alternatives.
In the context of used clothing, if the price drops, people are more likely to buy used clothes instead of new clothes.
This switch happens because individuals seek to maximize their utility—getting the most satisfaction for their money.
Thus, the more affordable used clothing becomes, the more people will opt for it over pricier new clothing options.

Income Effect

The income effect describes how a change in the price of a good affects consumers' purchasing power. When the price of a good falls, it's like having more disposable income, even if your actual income hasn't changed.
In essence, a lower price increases your real income because you can buy more with the same amount of money.
For example, if the price of used clothing decreases, consumers find that their money goes further, allowing them to purchase more used clothing or potentially other goods too.
This helps explain why sales of used clothing might rise during economic downturns when consumers are more price-sensitive and looking to stretch their budgets.

Law of Demand

The law of demand is one of the fundamental principles of economics. It states that, all else being equal, as the price of a good decreases, the quantity demanded of that good increases. Conversely, as the price increases, the quantity demanded decreases.
This inverse relationship between price and quantity demanded can be observed in the case of used clothing. When the price of used clothing falls, consumers are more likely to purchase more of it because it becomes more affordable.
This behavior is driven by both the substitution effect and the income effect.

Substitution effect: Consumers shift towards the cheaper used clothing.
Income effect: Lower prices make consumers feel wealthier, boosting their purchasing power.

Understanding the law of demand helps in predicting consumer behavior and making informed business decisions.