Answer to Question #274642 in Microeconomics for Shivu

Question

Explain the price effect, income effect and substitution effect of a price change for a normal

commodity using suitable diagram.?

Answer 1

The law of demand states that when the price falls, the quantity desired rises, but why? The substitution effect and the income impact are two factors that cause the demand curve to dip downward. According to the income effect, when the price of a good falls, it appears as though the buyer's income has increased. The substitution effect argues that when the price of a good lowers, consumers will switch from more costly goods to the less expensive good.

The income and substitution effects can also be utilized to explain the decreasing slope of the demand curve. The income effect argues that as the price of a commodity declines, real income — that is, what consumers can buy with their money income – rises, and customers raise their demand. As a result, at a reduced price, buyers can buy more with the same amount of money, and demand will rise, ceteris paribus. A rise in price, on the other hand, will reduce real income and force customers to reduce their demand.

Furthermore, as the cost of a thing decreases, it becomes more affordable. Assuming that other alternatives remain the same price, the good appears cheaper at reduced costs, and buyers will switch from the pricey to the relatively cheaper option. It's vital to note that if the price of a resource changes, both an income and a substitution effect are triggered.