Substitution Effect (Economics) - Explained
What is the Substitution Effect?
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Table of ContentsWhat is the Substitution Effect?How does the Substitution Effect Work?Demand Curve of the Substitution EffectAcademic Research on the Substitution Effect
What is the Substitution Effect?
The substitution effect is an economic concept based on how a change in the prices of goods or a change in income affects the number of goods demanded by consumers. When there is an increase in the prices of goods or decline in the income earned by consumers, their purchase trends change in such a way that they begin to substitute expensive goods for cheap products. In another vein, when consumers earn more income or prices of goods decrease, their appetite for luxurious goods resuscitate and they begin to substitute cheap products for expensive goods. This trend is described as the income effect.
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How does the Substitution Effect Work?
The substitution effect as a consumer choice theory reflects how consumption patterns and trends tend to change as a result of a change in the price of goods. Consumers replace expensive products for cheap products when there is a hike in the price of goods or when their income decreases. The same set of consumers are likely going to replace cheap products with luxurious and expensive ones when the prices of goods decrease or they get higher income. Products that substituted for another products, especially because they are cheaper are regarded as inferior goods. For example, when there is an increase in the price of a product and consumers see another product as a cheaper alternative that could probably serve the same purpose as the expensive one, the product is inferior. For instance, an increase in the price of rechargeable lamps can cause consumers to substitute rechargeable lamps for candles because they are cheaper, candles here are substitute goods. It is important to know that complementary goods are different from substitute goods, complementary goods have their needs attached to the purchase of another item. For instance, butter complements bread but not a substitute for bread.
Demand Curve of the Substitution Effect
Using a standard graph, the demand curve resulting from the substitution effect can pitched. On the graph, the Y-axis comprises of products A while the X-axis comprises of units of product B. Usually, the demand curve exhibited by these two axis develop a high downward slope movement in which there will be an increase in smaller slope as the units of product B rise. How consumers replace or substitute products when there is an increase in the price or decrease in income is graphically represented. The effect of the substitution on demand curve is also reflected.
- Ceteris Paribus
- Surplus and Shortage
- Theory of Price
- Price Sensitivity
- Price Control - Ceilings and Floors
- Microeconomic Pricing Model
- Dead Weight Loss
- Complements & Substitutes
- Substitution Effect
- Normal Good and Inferior Goods
- Giffen Good
- Veblen Good
- Consumer and Producer Surplus
- Economic Surplus
- Social Surplus
- Total Surplus