Downward sloping demand curves tell us that, if rental prices fall, people will tend to choose larger or nicer apartments and houses to rent. (For our purposes, renting a 'nicer' or renting a larger place are both increasing quantity consumed.) The reason people might choose nicer/bigger places due to a price change is two-fold.

As we noted before, a reduction in rent is like getting more income. If housing is a normal good (everything we know suggests that it is) then increases in income lead to increases in consumption. Renting a nicer place because of the greater available income due to the price reduction is called the income effect.

When rent falls, it also means that rental housing is now relatively cheaper than the other goods you buy, such as cars, clothing, education, etc. Renting a nicer place because it is now relatively cheaper compared to other goods is known as the substitution effect. As well see in the following pages, we can graphically separate these two effects and examine their separate roles in consumer decision making.

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