Substitution Effect Income Effect Price Effect Substitution Effect
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 0 Qx 1 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 0 Qx 1 Qx 0 Qx
Substitution Effect (S. E. ) 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 0 Qx 1 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 0 Qx 1 Qx 0 Qx
Income Effect (I. E. ) I Qx Normal Goods !!
Income Effect (I. E. ) I Qx Normal Goods !!
Income Effect (I. E. ) Normal Good Qy I Qx Qy Qx 0 0 Qx 1 Inferior Good I Qx 1 Qx 0 Qx Qx
Income Effect (I. E. ) Normal Good Qy I Qx Qy Qx 0 0 Qx 1 Qx 0 Inferior Good I Qx 0 Qx 1 Qx Qx
Income Effect (I. E. ) • Normal Good: • Inferior Good: I 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 0 Qx 1 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 0 Qx 1 Qx 0 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 Qx I I Qx inferior gd I -ve I 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. inferior gd I Qx Qx Case 2 Case 3
Summary -ve S. E. & +ve I. E. Qx & Qx Px -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 Qx 0’ Qx 1 Qx Qx
Graphically Case 1 Normal good Qy S. E. Qx -ve Px I. E. Qx +ve 0 Qx 0’ Qx 1 Qx Qx
Graphically Case 2 Inferior good, non-giffen case Qy S. E. Qx Px -ve S. E. I. E. Qx -ve 0 Qx 1 Qx 0’ Qx Qx
Graphically Case 2 Inferior good, non-giffen case Qy S. E. Qx Px -ve S. E. I. E. Qx -ve 0 Qx 1 Qx 0’ Qx Qx
Graphically Case 3 Inferior good, giffen case Qy S. E. Qx -ve Px S. E. I. E. Qx -ve 0 Qx 1 Qx 0’ Qx Qx
Graphically Case 3 Inferior good, giffen case Qy S. E. Qx -ve Px S. E. I. E. Qx -ve 0 Qx 1 Qx 0’ Qx Qx
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