Substitution Effect and Income Effect for Normal,

Inferior and Giffen goods

Substitution Effect
When the demand of a commodity “x” shifts to its substitute/competitor commodity “y” due to an
increase or decrease in the price of commodity x, it is known as Substitution Effect.

Normal Goods
↑P = ↓Q = Negative

↓P = ↑Q = Positive

Substitution effect for normal goods occurs when price of commodity “x” increases, consumers will
be more inclined to start consuming its substitute/competition commodity “y”, who’s price has not
changed. Vice versa when the price of commodity “x” decreases, consumers will be more inclined to
prefer consuming it over its substitute/competition commodity “y”.

For e.g., if the price of coke were to increase above the price of pepsi, demand for coke would
reduce as consumers would shift towards pepsi. However, if the price of coke were to decrease
below the price of pepsi, demand for coke would increase as consumers would shift from pepsi to
coke.

Inferior & Giffen Goods

↑P = ↑Q = Positive

↓P = ↓Q = Negative

Substitution effect for inferior goods occurs when price of commodity “x” decreases, consumers will
be more inclined to start consuming its substitute/competition commodity “y”, who’s price has not
changed. Vice versa when the price of commodity “x” increases, consumers will be more inclined to
prefer consuming it over its substitute/competition commodity “y”.

Income Effect
The change in demand of a commodity “x” due to a change in the real income of the consumer is
known as Income Effect.

Normal Goods
↓Income = Purchasing power decreasing = ↓Q

↑Income = Purchasing power increasing = ↑Q

Income effect on normal goods occurs when the real income of a consumer goes up. When the
consumer’s real income goes up, he has an increased purchasing power which results in him buying
more of the commodity.
Inferior & Giffen Goods
↓Income = Purchasing power decreasing = ↑Q

↑Income = Purchasing power increasing = ↓Q

Income effect on inferior & giffen goods occurs when the real income of a consumer goes up, he has
an increased purchasing power which results in him being able to afford better goods, i.e., normal
goods. This leads to the consumer buying less quantity of inferior or giffen goods.