Substitution Effect, Income Effect & Price Effect

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.

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

Px Qx
Qx
Qx0 Qx1

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

Px Qx
Qx
Qx1 Qx0

Substitution Effect (S.E.) Px Px Qx Qx

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.

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

I Qx
Qx
Qx0 Qx1

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

I Qx
Qx
Qx1 Qx0

Income Effect (I.E.) I I Qx Qx

Normal Goods !!

Income Effect (I.E.) I I Qx Qx

Normal Goods !!

Income Effect (I.E.)

Normal Good Inferior Good

I
Qy

Qx

I
Qy

Qx

Qx
Qx0 Qx1

Qx
Qx1 Qx0

Income Effect (I.E.)

Normal Good Inferior Good

I
Qy

Qx

I
Qy

Qx

Qx
Qx1 Qx0

Qx
Qx0 Qx1

Income Effect (I.E.)

Normal Good:

I
I

Qx Qx

Inferior Good:

I I

Qx Qx

Price Effect (P.E.)

Definition: It refers to the change in quantity demanded for a good caused by a change in relative price.

Price Effect (P.E.)

Definition: It refers to the change in quantity demanded for a good caused by a change in relative price. Qy

Px Qx
Qx
Qx0 Qx1

Price Effect (P.E.)

Definition: It refers to the change in quantity demanded for a good caused by a change in relative price. Qy

Px Qx
Qx
Qx1 Qx0

Relative price changes (S.E.) When price changes (P.E.)

Real income changes (I.E.)

P.E. = S.E. + I.E.

Relative price changes (S.E.) When price changes (P.E.)

Real income changes (I.E.)

P.E. = S.E. + I.E.

S.E. -ve
P.E.

Px Px

Qx Qx I Qx I Qx

I.E.

normal gd +ve

inferior gd I Qx -ve I Qx

Case 1

Qx

S.E. : Px Qx
P.E.
normal gd : I Qx +ve

Assume Px

I.E.
inferior gd : I Qx -ve

S.E. : Px Qx

Qx ?

P.E.

Px

normal gd : I Qx +ve

I.E.
inferior gd : I Qx -ve

Px Qx

S.E.

S.E. I.E.

Qx

Case 2

I.E.
inferior gd I Qx

S.E. I.E.

Qx

Case 3

Summary -ve S.E. & +ve I.E.

Qx & Qx

Qx

Case 1
normal gd

Px

-ve S.E. -ve I.E.

Qx Qx

Case 2
Qx inferior gd non-giffen case

-ve S.E. -ve I.E.

Qx Qx

Qx

Case 3
inferior gd giffen case

Graphically Case 1 Normal good

Qy

S.E. Qx
-ve

Px
I.E. Qx
+ve
0
Qx
Qx1

Qx

Qx0 Qx0

Graphically Case 1 Normal good

Qy

S.E. Qx
-ve

Px
I.E. Qx
+ve
0
Qx
Qx1

Qx

Qx0 Qx0

Graphically Case 2
Qy

Inferior good, non-giffen case

S.E. Qx

Px

-ve

S.E.I.E.

Qx

I.E. Qx
-ve

Qx0 Qx1 Qx0

Qx

Graphically Case 2
Qy

Inferior good, non-giffen case

S.E. Qx

Px

-ve

S.E.I.E.

Qx

I.E. Qx
-ve

Qx0 Qx1 Qx0

Qx

Graphically Case 3
Qy

Inferior good, giffen case

S.E. Qx

Px

-ve

S.E.I.E.

Qx

I.E. Qx
-ve

Qx1 Qx0

Qx0

Qx

Graphically Case 3
Qy

Inferior good, giffen case

S.E. Qx

Px

-ve

S.E.I.E.

Qx

I.E. Qx
-ve

Qx1 Qx0

Qx0

Qx