101 Concepts for the Level I Exam
Concept 18: Substitution and Income Effects
- When a good’s price falls, due to substitution effect consumers buy more of this good as compared to other goods for which the prices have remained the same.
- Substitution effect is always positive.
- When a good’s price falls, real income rises.
- If the good is a normal good, the income effect will be positive and more of this good will be purchased.
- If the good is an inferior good, the income effect will be negative and less of this good will be purchased.
- Giffen goods are highly inferior for which the negative income effect outweighs the positive substitution effect.
- Therefore even though price falls, the quantity demanded still decreases.
- Giffen goods have a positively sloped demand curve (which means that as price decreases the quantity demanded also decreases).
- Veblen goods are “high status” goods.
- If price increases, this makes the goods even more desirable and quantity demanded increases.
- Veblen goods also have a positively sloped demand curve (which means that as price increases the quantity demanded also increases).