Substitution Effect

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Substitution Effect

When the relative prices of two goods change so that one becomes cheaper than the other, the consumer would always try to substitute the cheaper goods for the relatively costlier one. Thus, in his consumption bundle he will have more of cheaper goods because some units of the other goods that has become relatively costlier have been replaced by this goods that has become relatively cheaper due to a fall in its price. This extent to which the quantity demanded of goods has increased purely due to the fact that now being cheaper it is being used to replace the costlier goods in the consumption bundle is called substitution effect. A fall in the price of goods increases its purchase due to working of income effect and substitution effect. Now, if with a fall in price of X we also reduce consumer’s money income in the same proportion of equilibrium where he still buys some more amount of X is the measure of substitution effect.


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