This phenomenon is called the income effect. Similarly, when the price of a particular product increases certain person opt to switch to any other low priced substitute goods. This is called the substitution effect. This clearly explains that there is a relation between income effect and substitution effect. That is, the substitution effect occurs as result of income effect.
2. Explain, using an income compensated demand curve, how a per unit tax on a good can reduce its consumption even if the government uses the tax revenue to make consumers as well off as they were before the tax was imposed.
The tax impact should be met by the consumers themselves. If there are any changes in the price of a commodity, it will ultimately affect the demand of such a product, and finally the income of the buyer also. There is an inverse relation between the demand and supply, but the price factor is also playing a key role in this context. If there is an increase in the price of a commodity, the total income level of the consumer will be affected.
"As shown in the Calculus of Hedonism, economists derive the individual demand curve from individual utility maps. Normally this results in the desired downward-sloping demand function, but there is a fly in the ointment to dispose of, since it is possible, though difficult, to draw a utility map which results in an upward sloping demand curve."
Upward Sloping Demand Curve with Inferior goods.
Separating the impact of a price change into the "income" and "substitution" effects
Compensated demand curve slopes downwards
Thus it becomes apparent that if any changes take place in the price pattern of a commodity, there should be a corresponding change in the income level of the consumer.
3. Explain, using consumer theory, why it might benefit companies (for example, mobile phone companies) to offer a menu of price and service options to consumers
Every consumer has his or her own rights to select the goods according to his or her taste and preferences. Consumers should give emphasis for the quality of goods and the price affordability. The consumer theory gives more focus on the concept of effective utilization of purchased goods and thereby the attainment of satisfaction.
The applicability of consumer theory is very beneficial in the case of cutthroat competition. Due to recent technological advancements, nowadays mobile phone companies are also functioning on the basis of modern economic principles. "Mobile commerce opportunities cover mobile initiatives that are designed to achieve strategic change in downstream activities through direct interaction with the customer. Customer knowledge must reach all the necessary parts of a mobile company to be useful, such as through an electronic knowledge repository. But mobile services involve more than just sending knowledge. They incorporate both technical and cultural challenges. To deliver superior service