Why Is Substitution Effect Important

When the price of a product or service increases but the buyer’s income stays the same, the substitution effect generally kicks in. The substitution effect is strongest for products that are close substitutes. An increase in consumer spending power can offset the substitution effect.

Why are the substitution and income effects important to demand?

The income effect states that when the price of a good decreases, it is as if the buyer of the good’s income went up. The substitution effect states that when the price of a good decreases, consumers will substitute away from goods that are relatively more expensive to the cheaper good.

What does the substitution effect measure?

The substitution effect measures the change in consumption such that the consumer’s level of utility does not change. The substitution effect can, therefore, be thought of as a movement along the same indifference curve. It results in a change in consumption from point X to point Y.