Income Effect vs Substitution Effect
Income Effect and Substitution Effect are two Consumer Choice concepts in AP Economics that students often mix up. In short: income effect is the income effect is the change in quantity demanded caused by a price change altering a consumer's real purchasing power. Meanwhile, substitution effect is the substitution effect is the change in quantity demanded when a price change makes a good relatively cheaper or pricier than its alternatives. Here is how they compare side by side.
The income effect is the change in quantity demanded caused by a price change altering a consumer's real purchasing power.
When a good's price falls, real income rises, so consumers can buy more. For normal goods the income effect raises quantity demanded; for inferior goods it works in the opposite direction. It is one of the two reasons demand curves slope downward.
The substitution effect is the change in quantity demanded when a price change makes a good relatively cheaper or pricier than its alternatives.
When a good's price falls, consumers substitute toward it and away from now relatively more expensive substitutes, raising quantity demanded. It always moves opposite to the price change. With the income effect, it explains the downward-sloping demand curve.
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