Income And Substitution Effect Inferior Good Price Increase

There is no universal standard to determine whether the income or substitution effect is more prevalent it all depends on personal preferences.

Income and substitution effect inferior good price increase. Thus on the basis of the methods of compensating variation the substitution effect measure the effect of change in the relative price of a good with real income constant. The income effect is what is left when the substitution effect a to c is subtracted from the total effect a to b which is b to c in the graph above. The substitution effect is explained in figure 12 17 where the original budget line is pq with equilibrium at point r on the indifference curve i 1. The increase in the real income of the consumer as a result of fall in the price of say good x is so withdrawn that he is neither better off nor worse off than before.

It means that when the price of the inferior good falls the consumer purchases more of it due to compensating variation in income. Its demand increases with decrease in income and vice versa. The price of leisure however increases since you re higher paid each foregone hour is more expensive suggesting you will work more substitution effect. X is an inferior good because when then the budget line shifts from b3 to b2 income decreases consumption of x increases from x3 to x2.

However when the price of an inferior good falls the consequence will be an increase in the quantity demanded because of significant negative income effect. Does the income effect or substitution effect dominate. The net effect equal the difference between substitution effect and income effect. Therefore consumption of inferior goods by a person decreases if income increases above a certain level.

The negative substitution effect is stronger than the positive income effect in the case of inferior goods so that the total price effect is negative. It is because an inferior good reacts differently to a change in income.