Income And Substitution Effect Of A Price Change Of An Inferior Good

It is because an inferior good reacts differently to a change in income.

Income and substitution effect of a price change of an inferior good. Its demand increases with decrease in income and vice versa. The substitution affect is always negative because when the price of a good falls or rises more or less of it would be purchased the real income of the consumer and price of the other good remaining constant. The net effect equal the difference between substitution effect and income effect. In case of an inferior goods also called giffen good the income effect and substitution effect work in opposite directions i e.

Thus in case of inferior goods the positive substitution effect x 1 x 3 is stronger than the negative income effect x 2 x 3. The change of relative prices is the substitution effect steep line to dotted line and the change of purchasing power is the income effect dotted line to parallel solid line what is the income effect. 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. 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 income effect expresses the impact of increased purchasing power on consumption while the substitution effect describes how consumption is impacted by changing relative income and prices. Thus income effect total price effect substitution effect. This for an inferior good means that les will be purchased when price falls. This implies that many of the inferior goods obey the law of demand.

Income effect arises because a price change changes a consumer s real income and substitution effect occurs when consumers opt for the product s substitutes. In other words the relation between price and quantity demanded being inverse the substitution effect is negative. The income effect is the change in consumption patterns due to a change in purchasing power. It means that when the price of the inferior good falls the consumer purchases more of it due to compensating variation in income.

If the price of an inferior good falls the substitution effect will still cause a larger commodity. Substitution effect and income effect. Economic theory cannot tell us whether the income effect or substitution effect will predominate. 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.

I e income effect x 1 x 2 x 1 x 3 x 2 x 3.