BASICS OF

MICROECONOMI
CS
-1293
The basic theory of microeconomics affects consumer preference due to price change with
income effect, price effect and substitution effect.

The Income Effect Income effect refers to when a consumers real income gets affected due to
the change in the price of the commodity and affects the individual demand for that commodity.
The Substitution Effect The substitution effect refers to a situation where depending on the rise
or fall in the price of the commodity, the demand for the commodity increases or decreases
accordingly.
The Price Effect - A combination of the income effect and substitution effect is the price effect.
Ever since we have come to college, all of us have been struggling with money management.
Living in the hostel, we all crave for tasty food because of having to eat in the mess; we have to
buy supplies for Aesthetics and Visual Communication as well. I totally have Rs 300 to spend on
supplies for Aesthetics and Visual Communication. When the price of supplies reduced, I had Rs
100 extra to spend.
Now I have three choices:1. Buy more of supplies that cost Rs 100 and have more of them, which will completely
constitute the substitution effect.
2. I can decide to spend the money I save on something else entirely, which will completely
constitute the income effect.
3. I can decide to buy a little more of supplies and spend the rest on something else, which
would constitute both substitution effect and income effect.
I decided to spend the extra money on buying food from the canteen, to break the monotony.
Now, my income effect is 100 as I decide to entirely spend the money I save on buying supplies,
and makes my substitution effect is 0 because even though I have the money to buy more
supplies, I decide not to at all.