Question

With gas prices rising, many people say they are staying in and scaling back spending to try to keep within their budget. They are driving as little as possible, cutting back on shopping and cating out, and reducing other discretionary spending. How does a rise in the price of gasoline change the relative price of a restaurant meal? How does a rise in the price of gasoline change real income in terms of restaurant meals?

Short answer

A rise in gas prices increases the relative price of gasoline compared to restaurant meals. It decreases real income in terms of restaurant meals because people can afford fewer of them with their fixed income.

Step-by-step solution

Understand the concept of relative price

Relative price is the price of one good or service compared to another. When talking about how a rise in the price of gasoline affects the relative price of restaurant meals, we need to see how the increase in gas prices influences people's ability to spend on other things, like restaurant meals.

Analyze the impact of rising gas prices on budgets

As gas prices rise, people have to allocate more of their budget to gasoline. This means they have less money to spend on other things, including dining out. Hence, the opportunity cost of spending money on restaurant meals increases.

Calculate the relative price change

When the price of gasoline goes up, you effectively have to give up more restaurant meals to buy the same amount of gasoline. This implies that the relative price of a restaurant meal, in terms of how much gasoline you have to give up, has decreased.

Understand the concept of real income

Real income measures how much you can buy with your income, considering changes in prices. If gas prices go up and incomes remain the same, the overall purchasing power decreases.

Evaluate the effect on real income in terms of restaurant meals

As gas prices rise, people have less disposable income to spend on other items, including restaurant meals. Therefore, their real income in terms of dining out has decreased because they can now afford fewer restaurant meals than before.

Key concepts

Understanding Relative Price

Relative price is a key concept in economics. It’s the price of one good compared to another. This ratio helps people decide how to allocate their limited resources. For instance, with rising gas prices, the relative price of dining at a restaurant changes.
If gas becomes more expensive, you’re forced to spend more money on fuel, leaving less for other activities. This essentially means that although the price of restaurant meals hasn’t increased, you feel as if it has because you have less money left to spend.
In this way, even if restaurant prices remain stable, the relative affordability of dining out compared to purchasing gas has decreased. More money spent on gas means less is available for dining out, changing the relative costs.

Exploring Opportunity Cost

Opportunity cost is about the trade-offs we face in our financial decisions. It's the benefit you miss out on when choosing one option over another. With higher gas prices, the opportunity cost of other purchases increases.
If you decide to spend more on gas, you have to cut back on other expenses. This is where opportunity cost comes in. You might have to give up going to a few restaurants to balance your budget. In simple terms, driving more means dining out less.
The opportunity cost highlights the choices and sacrifices we make in our spending. When gas prices rise, the opportunity cost of eating out goes up, as the funds spent on additional fuel could have otherwise gone toward more restaurant visits.

Impact on Real Income

Real income is the purchasing power you hold after accounting for changes in prices. It's not just about how much money you earn, but what that money can buy you.
When gas prices increase and your income remains unchanged, your real income decreases. This is because you can now buy fewer goods and services with the same amount of money. For example, if you previously used to dine out four times a month, you might now only afford to dine out twice, due to the extra money spent on gas.
Real income thus directly impacts lifestyle choices and the ability to maintain previous consumption levels. Rising gas prices shrink your real income, reducing the amount you can spend on other things like restaurant meals, leisure activities, or shopping.

Effect on Disposable Income

Disposable income is the amount of money left after paying taxes and necessary expenses, such as rent and utilities. It's what you can spend on non-essentials, like entertainment and eating out.
As gas prices go up, more of your disposable income gets directed towards necessary expenses. This leaves you with less money for discretionary spending. Cutting back on dining out becomes a common adjustment.
Your spending habits change to accommodate the increase in gas prices. For instance:

• Instead of eating out, you might cook more at home.
• Your leisure activities may be limited to less costly options.

Rising gas prices force a reorganization of your disposable income, primarily reducing funds available for non-essential expenses.