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

Qx0

Qx1

Qx

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

Qx1

Qx0

Qx

Substitution Effect (S.E.)

Px

Qx

Px

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

Qx0 Qx1

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.
Qy

I
Qx

Qx1 Qx0

Qx

Income Effect (I.E.)

I

Qx

Qx
Normal Goods !!

Income Effect (I.E.)

I

Qx

Qx
Normal Goods !!

Income Effect (I.E.)

Normal Good

Qy

Qx

Qy

Qx

0
Qx0 Qx1

Inferior Good

Qx1 Qx0

Qx

Qx

Income Effect (I.E.)

Normal Good

Qy

Qx

Qy

Qx

0
Qx1 Qx0

Inferior Good

Qx0 Qx1

Qx

Qx

Income Effect (I.E.)

Normal Good:

Inferior Good:

Qx

Qx

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

Qx0

Qx1

Qx

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

Qx1

Qx0

Qx

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.
P.E.
I.E.

-ve

Px
Px

Qx
Qx
I
I

Qx
Qx

inferior gd I
-ve
I

Qx
Qx

normal gd
+ve

Case 1

Qx

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

P.E.

Assume Px

I.E.
inferior gd : I Qx
-ve

S.E. : Px Qx
P.E.

normal gd : I Qx
+ve

Px

I.E.
inferior gd : I Qx
-ve

Qx ?

S.E.

Px Qx

S.E. I.E.

I.E.

S.E. I.E.

inferior gd
I Qx

Qx

Qx

Case 2

Case 3

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

Px

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

Qx Qx

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

Qx Qx

Qx

Case 1
normal gd

Case 2
Qx inferior gd
non-giffen case

Qx

Case 3
inferior gd
giffen case

Graphically
Case 1 Normal good
Qy

S.E. Qx
-ve

Px
I.E. Qx
+ve
0

Qx0 Qx0

Qx1

Qx

Qx

Graphically
Case 1 Normal good
Qy

S.E. Qx
-ve

Px
I.E. Qx
+ve
0

Qx0 Qx0

Qx1

Qx

Qx

Graphically
Case 2

Inferior good, non-giffen case

Qy

S.E. Qx

Px

-ve

S.E.I.E.

I.E. Qx
-ve

Qx0 Qx1 Qx0

Qx

Qx

Graphically
Case 2

Inferior good, non-giffen case

Qy

S.E. Qx

Px

-ve

S.E.I.E.

I.E. Qx
-ve

Qx0 Qx1 Qx0

Qx

Qx

Graphically
Case 3

Inferior good, giffen case

Qy

S.E. Qx
-ve

Px

S.E.I.E.

I.E. Qx
-ve

Qx1 Qx0

Qx0

Qx

Qx

Graphically
Case 3

Inferior good, giffen case

Qy

S.E. Qx
-ve

Px

S.E.I.E.

I.E. Qx
-ve

Qx1 Qx0

Qx0

Qx

Qx