What is the substitution effect?

La microeconomía it is a theory that studies the economic behavior of individual agents. Not only does it analyze the preferences of the consumer and the different consumer goods that exist, but also investigates some economic trends such as the substitution effect. This concept, which has been analyzed and quantified thanks to the methods of Hicks and Slutsky, can be explained as follows.

When does the substitution effect occur?

The concept of substitution effect refers to the change in demand for a good or service when the following variables are met:

  • That the price of other goods and services remains stable.
  • That the purchasing power of consumers remains the same.

What does this mean? That if a product becomes more expensive (1st) and there are other similar products that have not experienced any variation in value (2nd), the consumer will start consuming the second product instead of the first.

How is the substitution effect different from the income effect?

The substitution effect is often confused with the income effect, since both can be observed in similar examples. However, the variation in consumption that the substitution effect supposes is totally unrelated to the change in the real income of consumers. Contrary to the income effect, in which the purchasing power of consumers is reduced, in the substitution effect no change is observed in real income.

The sum of the substitution effect with the rent effect (also known as the income effect) will result in the price effect.

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