Econ: What are Income and Substitution Effects?

What are Income and Substitution Effects? Income effects reflects the increases or decreases in total consumption of goods and services in proportion to income level changes. Substitution effects refers to the changes in quality, i.e. upgrade or downgrade in consumption choices as income levels change.

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Transcript

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prices change or our pay changes like our salaries which

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makes us then do a double take right Well the

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income effect describes how a change in income changes a

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consumer's demands Getting a pay raise increases purchasing power which

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increases demand for goods and services while taking a pay

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cut will lower purchasing power in consumer demand The substitution

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effect describes how people substitute one good for another when

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either prices income changes or a new rival good arrives

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on the market For both the income in substitution effect

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it's common that as income rises inferior goods are replaced

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with normal goods which includes you know fancy luxury goods

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Well inferior goods are goods whose demand decreases when income

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rises Right like people want less of that crappy box

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Rice and more of the freezer frozen expensive good rice

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Normal goods are the opposite Demand increases for them as

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income rises Like if we look att coffee in the

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McDonald's coffee is an inferior good while Starbucks coffee is

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a normal good rights more expensive more lavish more lugs

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for getting a ride to work while busing is an

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inferior service compared to getting a taxi If anyone drives

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those things anymore or anywhere the richer we get the

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more we spend in the more we switch out inferior

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goods for normal goods For instance you're shopping for toilet

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paper Yes we all do Last week's pay raise might

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mean you stock up more on toilet paper like never

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before using it to line your walls of your house

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because well you can mo money mo tp write thie

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income effect is then at work or your pay raise

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might mean you buy the same amount of toilet paper

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as before But you buy the super soft yet super

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sturdy gold lined fancy toilet paper with the talcum powder

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All in it Yes cream oblique soft to go with

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your you know new golden toilet of course because you're

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substituting your inferior toilet and toilet paper with a luxury

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toilet and toilet paper We're looking at the substitution effect

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but hold up Buying a gold toilet in gold lined

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toilet paper because you've got a raise also falls under

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the income effect umbrella since it's a change in your

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consumption caused by a change in your income Yet the

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income effect and substitution of facts can both apply to

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the same situation So let's take a look at a

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price change instead of any income change in this parallel

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universe You did not get a raise Let's say the

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gold lined toilet paper wasn't selling too well on the

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market for some odd reason it kind of itches there

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So it went on mega sale In fact the gold

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lined toilet paper was cheaper than the toilet paper you

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usually buy so you substitute your normal teepee with the

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luxury TP Since your income stayed the same Well there's

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no income effect to be found here and no gold

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toilets Unfortunately this is another example of the substitution effect

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at work Your favorite wine is a nice Napa Valley

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cab cabernet there that usually retails for fifty bucks a

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bottle Unfortunately California's hit by yet another set of wildfires

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and half the inventory of your favorite wine is destroyed

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prices skyrocket was fifty bucks a bottle Now it's one

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hundred more than you're willing to pay for a bottle

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of hooch So you switch to two buck chuck until

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prices get back to normal So to recap the income

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effect is changes in consumption based on changes in your

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income More money more buying power which means greater demand

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in the consumer market less money less buying power which

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means lower demand in the market Whether the quantity or

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quality of what you're buying changes doesn't make a whole

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lot of difference is just a change in how much

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you're spending We're talking about here Well the substitution effect

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is when you switch out one good for another whether

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from an income change or a price Change more money

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or slashed prices while time to trade up less money

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or prices than rose Well time to trade down And

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then you get laid off from your job and have

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to take a gig working at a call centre for

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half your previous salary The dark side of the income

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effect No more gold lined toilet paper for Gyu Instead

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you're stealing TP from the bathroom at McDonald's trade in

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that Cadillac you releasing Switch to a line scooter instead

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Also no more sushi lunches Instead Gore buying canned tuna

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in bulk at Walmart for ninety nine cents a serving

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and brown bagging homemade tuna salad sandwiches toe work and

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forget the weekly massages at the spa Yeah Instead you're

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plunking quarters into the massage chair they have at the

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malls here So good luck with that Yeah So those

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are income and substitution effects there Yeah Pretty sexy or 00:04:52.519 --> [endTime] not What