Income vs Substitution Effect Explained
The Income Effect says you buy more of a normal good when your real purchasing power rises; the Substitution Effect says you switch to the cheaper good when its relative price falls.
People mash these up because both pop up after a price change, and both shift buying habits. One feels like “I can afford it now,” the other like “this deal is too good to pass up.”
Key Differences
Income Effect: You feel richer, so quantity rises. Substitution Effect: The cheaper good looks better, so quantity rises. Same outcome, different engine.
Which One Should You Choose?
Both always act together. You don’t pick; you observe. Ask: “Am I feeling wealthier, or just chasing a bargain?” That tells you which force is louder.
Examples and Daily Life
Your bus fare drops. You ride more because it’s cheaper (substitution) and you might now grab extra coffee since you saved money (income).
Does the Income Effect ever shrink demand?
Yes, for “inferior” goods like instant noodles; higher real income can push you toward pricier meals.
Can the Substitution Effect push you away from a cheaper good?
Only if another good becomes even cheaper relative to it.