What are income and substitution effects?
A fall in the price of a good has two effects: Substitution & Income Consumers will tend to buy more of the good that has become relatively cheaper, and less of the good that is now relatively more expensive. Consumers experience an increase in real purchasing power when the price of one good falls. The substitution effect is the change in an item’s consumption associated with a change in the price of the item, with the level of utility held constant. When the price of an item declines, the substitution effect always leads to an increase in the quantity of the item demanded. The income effect is the change in an item's consumption brought about by the increase in purchasing power, with the price of the item held constant. When a person’s income increases, the quantity demanded for the product may increase or decrease. Even with inferior goods, the income effect is rarely large enough to outweigh the substitution effect.
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