Household behavior and consumer choice

As long as a household faces a limited budget---and all households ultimately do---the real cost of any good or service is the value of the other goods and services that could have been purchased with the same amount of money. The real cost of a good or service is its opportunity cost, and opportunity cost is determined by relative prices.

The budget constraint is affected by income, wealth and price. Within those limits, consumers are free to choose (capacity) and their ultimate choice is based on preferences (willingness)

How price change affects household behavior:
(1)The change in consumption of X due to the improvement of well-being is call the income effect of a price change.
(2)When a product's prices fall, it's cheaper and relatively more attractive than its substitutes. Thus consumers may shift from substitutes to this specific product. This shift is called substitute effect of a price change.


Suppose the trip from A to B is reduced from $400 to $200, but at the same time my income is reduced by $800, but it's still likely that I will take more trip to B because the opportunity cost of a trip from A to B is now lower. I may substitute away from other goods toward the trip from A to B.

Income and substitution effects if a wage change
(1)If leisure is a normal good, an increase in income will lead to a higher demand for leisure and a lower labor supply, which is the income effect of a wage change.
(2)A higher wage rate means that leisure is more expensive. If you think of the wage rate as the price of leisure, each individual hour of leisure consumed at a higher wage costs more in forgone wages. As a result, we would expect households to substitute other goods for leisure. This means working more, or a lower quantity demanded if leisure and a higher quantity supplied of labor.