3. Substitution Effect, Income Effect, Normal and Inferior Goods
b. compare substitution and income effects;
c. distinguish between normal goods and inferior goods;
What is substitution effect?
When the price of a good declines, consumers buy more of it, even if they have to give up other products. They are, in effect, substituting this product for other products.
What is the income effect?
When a consumer is on a fixed budget, and the price of a good declines, they effectively have more money to spend, so they buy more of the thing that dropped in price.
What is the Giffen effect?
When a good is inferior and the income effect outweighs the substitution effect, it is called a Giffen good. This is, however, unlikely, because the substitution effect is almost always stronger than the income effect.
What is a Veblen good? What does the demand curve for a Veblen good look like?
For a Veblen good, an increase in price causes an increase in demand. This results in an upward-sloping demand curve. Think about associating a higher price with more status, luxury, quality, etc.