Substitution and Income effects

Substitution and Income effects - on two brands of soap....

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Substitution and Income effects: Marginal utility, equimarginal utility or law of demand in general, help to analyze consumer behavior. Price and the quantity of a good are generally inversely related. This means that the consumption or demand of a good increases if its price falls and the consumption or demand of a good decreases if its price rises. There are two distinct effects that underlie such an inverse tendency. They are known as substitution and income effects . Substitution effect means the tendency of a consumer to reduce the consumption of a relatively dearer good and to increase the consumption of a relatively cheaper good. As a result of this, the consumption or demand of a good whose price has fallen, increases. For example: let a consumer spend a total amount of $10 in equal proportion of $5 each
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Unformatted text preview: on two brands of soap. Both varieties of soap perform the same function and therefore are substitutes of each other. If the price of one of the brands falls, it becomes cheaper. The consumer may then spend more (say $7) on it and increase the demand for the cheaper brand?. On the other hand, he is left with only $3 which he spends on the second brand. The demand for the second brand which is relatively dearer, therefore decreases. Such an act of shifting demand from a dearer to a cheaper good is called the substitution effect . This kind of an effect works in the inverse direction: a fall in price results in a rise in demand and is therefore negative in its influence....
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This note was uploaded on 11/26/2011 for the course ECON MICRO ec 201 taught by Professor - during the Fall '10 term at Montgomery.

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Substitution and Income effects - on two brands of soap....

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