LESSON 8

CHANGES IN INCOME
OBJECTIVES
On completing the module, you should be able to:
* Determine the Impact of a Price Change
* Analyze and Discuss the Substitution and Income
Effect
 The Impact of a Price Change
Economists often separate the impact of a price change into two components:
-The substitution effect; and
-The income effect.
The substitution effect involves the substitution of good x₁ for good x₂ or vice
versa due to a change in relative prices of the two goods.
The income effect results from an increase or decrease in the consumer’s real
income or purchasing power as a result of the price change.
The sum of these two effects is called the price effect.
Income Effect
Is represented by the movement from point C to A.
In other words, it will be ST.
Price effect =SQ
Substitution effect =TQ
Income effect = ST
Thus, SQ (Price Effect= TQ (Substitution effect) + ST
(Income effect)
Substitution Effect
Is represented by the movement from original
equilibrium point E to E both points being situated
on the same indifference curve.
 
Income Effect
Is represented by the NT.
The main reason for buying the combination
indicated by E is that despite income of the
consumer being constant he substitutes relatively
cheaper.
Thus, MT (Price effect) = MN (Substitution effect) +
NT (Income effect)
THANK YOU!!!