Demand - Curve Analysis &

Income - Substitution Effect

By : Pankaj Chomal
MBA (Executive)
 Income and Substitution Effect :
Various Effects

 Income Effect : The money saved can be used for
buying another commodities. This can be termed as
Additional Income. E.g. when the Income increases,
individuals buys expensive products instead of inferior
products.
 Substitution Effect : It’s an effect which is caused by rise
in prices that induces a consumer to buy a relatively
lower-priced good and less of a higher-priced one. This is
forced to occur due to fall in Income or rise in prices.
 Price Effect : The impact that a change in value has on
the consumer demand for a product or service in the
market. It’s the final shifting from Original to Actuals.
 Income and Substitution Effect :
Example to Explain

 I had a car, which was running
only on Petrol. However, due to
rise in prices of Petrol, I got the
CNG kit fitted in my car

 However, the prices

of Petrol and CNG
were almost same
 Income and Substitution Effect :
Example to Explain…

My monthly budget for my fuel
consumption was ` 1000.
Of which ` 500 was spent on
Petrol and ` 500 on CNG.
However, due to increase in
subsidy and to encourage people
to use more CNG, CNG prices had
fallen almost to half.
 Income and Substitution Effect :
Example to Explain…
Condition Income

CNG Petrol

`500 (Price) `500 (Price)

Original Condition ` 1000
10 kg (Quantity) 10 ltr (Quantity)

When price of CNG ` 375 (Price) `250 (Price)

reduced. Bought
double CNG and ½ ` 750 20 kg (Quantity) 5 ltr (Quantity)
Petrol
Substitution Effect
From money saved `0 (Price) `250 (Price)
bought additional ` 250 0 kg (Quantity)
Petrol. 5 ltr (Quantity)
Income Effect
From money saved 20 kg CNG in ` 375 10 ltr Petrol in `500
bought some more
CNG and saved some Final Outcome
money as well.
 Income and Substitution Effect :
Example to Explain…

Substitution Effect:
The substitution effect moves the
consumer from the bundle labeled
A to the bundle labeled A’.

The graph showing the

substitution effect associated
with a decrease in the price of
CNG
 Income and Substitution Effect :
Example to Explain…

Income Effect:
The total effect of the decrease in
the price of CNG is the move from
point A to point B. The move from
A’ to B is the income effect

The graph shows the income

effect of a decrease in the price
of CNG on Individual’s
maximizing consumption
decision.