Answer to Question #110808 in Microeconomics for Hamza malik

Question

What is income and subsituation effect

Answer 1

Income Effect and Substitution effect is explained as follows :

Income Effect

As per the Income effect in economics, income effect is the increase in the consumption when the income increases and decrease in the consumption when the income decrease.

Because of the Income effect amount spent on consumption will increase or decrease based on the increase or decrease in the income. However, the consumption need not to be of the same goods.

Substitution effect

According to substitution effect a consumer may switch to substitute goods depending on the change in the income. For e.g. if the income is increasing the consumer may spend more on luxury goods similarly if the income is decreasing the consumer may spend more on goods which have same utility but are of less price.