SUBSTITUION EFFECT

by • 24/06/2011 • B.COM PART 1 EconomicsComments (0)562

Substitution effect may be defined as a measure of the change in the quantity of goods purchases which is solely due to a change in relative prices, real income of the consumer remaining constant.”

Explanation:

Income

Price X

Price Y

Budget Line

1st

Rs. 10

2

1

AA

2nd

Rs. 10

1

1

AB

In this figure, initial income of consumer is Rs. 10 and price of X=2 and Price of Y=1 and consumer can purchase 5 units of Y and 2.5 units of X with equilibrium at E1.

When price of X = 1 reduces, the equilibrium of consumer shifted to E2 and the difference between E1 and E2 is showing the substitution effect.

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