Economics

Demand - Curve Analysis &Income - Substitution Effect

By : Pankaj ChomalMBA (Executive)

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 :

Various Effects

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

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

Original Condition ` 1000

`500 (Price) `500 (Price)

10 kg (Quantity) 10 ltr (Quantity)

When price of CNG reduced. Bought double CNG and ½ Petrol Substitution Effect

` 750

` 375 (Price) `250 (Price)

20 kg (Quantity) 5 ltr (Quantity)

From money saved bought additional Petrol. Income Effect

` 250

`0 (Price)0 kg (Quantity)

`250 (Price)

5 ltr (Quantity)

From money saved bought some more CNG and saved some money as well. Price Effect

Final Outcome

20 kg CNG in ` 375 10 ltr Petrol in `500

Income and Substitution Effect :

Example to Explain…

Income and Substitution Effect :

Example to Explain…

The graph showing the substitution effect associated with a decrease in the price of CNG

Substitution Effect:The substitution effect moves the consumer from the bundle labeled A to the bundle labeled A’.

Income and Substitution Effect :

Example to Explain…

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

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

Thanks!!