The price change effect on consumption can be broken down into two parts depending upon the change relative in pricing of products and income. The first one is called substitution effect wherein price change of a product leads to change in consumption, here the income remains constant. The second is the income effct wherein the relative income of people changes which leads to a change in the purchasing power, here the price is considered constant.
* prices change >> income, prices both change relatively * substitution effect - price changes >> relative prices of good changes * willing to buy more of good that became relatively cheaper * price change for 1 good relatively effects the other good as well * utility stays constant, price declines >> demand increases * causes shift along indifference curve (to point where more of one good bought than before) * income effect - price falls >> relative income increases >> increase in real purchasing power * price held constant (as if income increased), quantity demanded depends on whether good is inferior/normal * outward or inward shift to new demand curve
* inferior good >> inward shift >> may or may not overtake substitution effect * may be large enough to cause demand to slope upward (stop consuming some other good completely
Price effect is the Impact on prices due to of a change in interest rates. The effect of a price change on demand for a product.
If you were to receive a 10% increase in your hourly wage, would you increase, decrease, or maintain your hours worked? Believe it or not, any answer is correct, despite many assumptions regarding the positive slope of labor supply curves. The reason that any answer is correct lies in an understanding of substitution and income effects.
The substitution effect is the change in consumption patterns due to a change in the relative prices of...