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Substitution Effect, Income Effect & Price Effect
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Substitution Effect (S.E.)
Definition: It refers to the change in quantity demanded for a good caused by a change in relative price, holding real income constant.
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Substitution Effect (S.E.)
Definition: It refers to the change in quantity demanded for a good caused by a change in relative price, holding real income constant. Qy Qx Px Qx Qx0 Qx1
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Substitution Effect (S.E.)
Definition: It refers to the change in quantity demanded for a good caused by a change in relative price, holding real income constant. Qy Qx Px Qx Qx1 Qx0
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Substitution Effect (S.E.)
Qx Px Qx Px
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Income Effect (I.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in real income, holding relative price constant.
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Income Effect (I.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in real income, holding relative price constant. Qy Qx I Qx Qx1 Qx0
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Income Effect (I.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in real income, holding relative price constant. Qy Qx I Qx Qx0 Qx1
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Income Effect (I.E.) Qx I Qx I Normal Goods !!
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Income Effect (I.E.) Qx I Qx I Normal Goods !!
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Income Effect (I.E.) I Qx I Qx Normal Good Inferior Good Qy Qy Qx Qx
Qy Qx Qx1 Qx1 Qx0 Qx0
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Income Effect (I.E.) I Qx I Qx Normal Good Inferior Good Qy Qy Qx Qx
Qy Qx Qx0 Qx0 Qx1 Qx1
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Income Effect (I.E.) Qx I Normal Good: Inferior Good: Qx I Qx I I Qx
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Price Effect (P.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in relative price.
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Price Effect (P.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in relative price. Qy Qx Px Qx Qx0 Qx1
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Price Effect (P.E.) Definition: It refers to the change in quantity demanded for a good caused by a change in relative price. Qy Qx Px Qx Qx1 Qx0
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When price changes (P.E.)
Relative price changes (S.E.) When price changes (P.E.) Real income changes (I.E.) P.E. = S.E. + I.E.
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When price changes (P.E.)
Relative price changes (S.E.) When price changes (P.E.) Real income changes (I.E.) P.E. = S.E. + I.E.
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S.E. P.E. I.E. Px Qx Px Qx -ve I Qx I Qx normal gd +ve
inferior gd -ve I Qx I Qx
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Case 1 S.E. : Px Qx P.E. Assume Px I.E. Qx normal gd : +ve
I Qx I.E. inferior gd : -ve I Qx
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S.E. : Px Qx P.E. Px I.E. Qx ? normal gd : +ve I Qx
inferior gd : -ve I Qx
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S.E. Case 2 S.E. I.E. Case 3 I.E. S.E. I.E.
Px Qx Case 2 S.E. I.E. Qx Case 3 I.E. inferior gd I Qx S.E. I.E. Qx
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Summary Case 1 -ve S.E. & +ve I.E. Case 2 -ve S.E. -ve I.E. Px
normal gd -ve S.E. & +ve I.E. Qx & Qx Qx Case 2 inferior gd non-giffen case -ve S.E. -ve I.E. Qx Qx Qx Px Case 3 inferior gd giffen case -ve S.E. -ve I.E. Qx Qx Qx
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Graphically Case 1 Normal good S.E. Qx Qx Px Qx I.E. -ve +ve
Qy Qx S.E. -ve Qx Qx Px Qx I.E. +ve Qx0 Qx1 Qx0’
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Graphically Case 1 Normal good S.E. Qx Qx Px Qx I.E. -ve +ve
Qy Qx S.E. -ve Qx Qx Px Qx I.E. +ve Qx0 Qx1 Qx0’
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Inferior good, non-giffen case
Graphically Case 2 Inferior good, non-giffen case Qy Qx S.E. -ve Qx Qx S.E.I.E. Px I.E. -ve Qx Qx1 Qx0 Qx0’
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Inferior good, non-giffen case
Graphically Case 2 Inferior good, non-giffen case Qy Qx S.E. -ve Qx Qx S.E.I.E. Px I.E. -ve Qx Qx1 Qx0 Qx0’
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Inferior good, giffen case
Graphically Case 3 Inferior good, giffen case Qy Qx S.E. -ve Qx Qx S.E.I.E. Px I.E. -ve Qx Qx1 Qx0 Qx0’
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Inferior good, giffen case
Graphically Case 3 Inferior good, giffen case Qy Qx S.E. -ve Qx Qx S.E.I.E. Px I.E. -ve Qx Qx1 Qx0 Qx0’
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