Substitution Effect, Income Effect & Price Effect

1. Substitution Effect,Income Effect&Price Effect

2. 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.

3. Qy Px Qx Qx 0 Qx0 Qx1 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.

4. Qy Px Qx Qx 0 Qx1 Qx0 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.

5. Qx Px Qx Px Substitution Effect (S.E.)

6. 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.

7. Qy I Qx Qx 0 Qx0 Qx1 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.

8. Qy I Qx Qx 0 Qx1 Qx0 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.

9. Qx I Qx I Income Effect (I.E.) Normal Goods !!

10. Qx I Qx I Income Effect (I.E.) Normal Goods !!

11. Qx Qy Qy Qx I I Qx Qx 0 0 Qx1 Qx0 Qx0 Qx1 Inferior Good Normal Good Income Effect (I.E.)

12. Qx I Qx I Qy Qy Qx Qx 0 0 Qx0 Qx1 Qx1 Qx0 Inferior Good Normal Good Income Effect (I.E.)

13. Income Effect (I.E.) • Normal Good: • Inferior Good: Qx I Qx I Qx I I Qx

14. Price Effect (P.E.) • Definition: It refers to the change in quantity demanded for a good caused by a change in relative price.

15. Qy Px Qx Qx 0 Qx0 Qx1 Price Effect (P.E.) • Definition: It refers to the change in quantity demanded for a good caused by a change in relative price.

16. Qy Px Qx Qx 0 Qx1 Qx0 Price Effect (P.E.) • Definition: It refers to the change in quantity demanded for a good caused by a change in relative price.

17. Relative price changes (S.E.) When price changes(P.E.) Real income changes (I.E.) P.E. = S.E. + I.E.

18. Relative price changes (S.E.) When price changes(P.E.) Real income changes (I.E.) P.E. = S.E. + I.E.

19. Px  Qx  Px  Qx  S.E. -ve P.E. I  Qx  I  Qx  normal gd +ve I.E. inferior gd -ve I  Qx  I  Qx 

20. Case 1 P.E.Assume Px  Qx  S.E. : Px  Qx  normal gd : +ve I  Qx  I.E. inferior gd : -ve I  Qx 

21. P.E. Px  S.E. : Px  Qx  Qx ? normal gd : +ve I  Qx  I.E. inferior gd : -ve I  Qx 

22. S.E. Px  Qx  Case 2 S.E.  I.E. Qx  Case 3 I.E. inferior gd I  Qx  S.E.  I.E. Qx 

23. Summary Case 1 normal gd -ve S.E. & +ve I.E. Qx  & Qx  Qx  Case 2 inferior gd non-giffen case -ve S.E.  -ve I.E. Qx   Qx  Qx  Px  Case 3 inferior gd giffen case -ve S.E.  -ve I.E. Qx   Qx  Qx 

24. Qy Qx 0 Qx0’ Qx0 Qx1 Graphically Case 1 Normal good S.E. -ve Qx  Qx  Px  Qx  I.E. +ve

25. Qy Qx 0 Qx0’ Qx0 Qx1 Graphically Case 1 Normal good S.E. -ve Qx  Qx  Px  Qx  I.E. +ve

26. Qy Qx 0 Qx1 Qx0’ Qx0 Graphically Case 2 Inferior good, non-giffen case S.E. -ve Qx  Qx  S.E.I.E. Px  I.E. -ve Qx 

27. Qy Qx 0 Qx1 Qx0’ Qx0 Graphically Case 2 Inferior good, non-giffen case S.E. -ve Qx  Qx  S.E.I.E. Px  I.E. -ve Qx 

28. Qy Qx 0 Qx1 Qx0 Qx0’ Graphically Case 3 Inferior good, giffen case S.E. -ve Qx  Qx  S.E.I.E. Px  I.E. -ve Qx 

29. Qy Qx 0 Qx1 Qx0 Qx0’ Graphically Case 3 Inferior good, giffen case S.E. -ve Qx  Qx  S.E.I.E. Px  I.E. -ve Qx 