Question

Can income and substitution effects have an influence on a decision maker at the same time?

Answer 1

Yes, income and substitution effects can have an influence on a decision maker at the same time.

For instance, consider a consumer who has been consuming oranges for a while now. If the price of oranges happens to fall, then the consumer will start consuming more of it, or we can say, substitute towards consuming it more, because of substitution effect. Also, this fall in price has increased the buying power of the consumer, so now the same amount of money as before can buy more oranges. Hence as per the income effect, more oranges are consumed.

Therefore, both income and substitution effects are at work simultaneously.

Also, price effect = income effect + substitution effect.

Hence the overall price effect leads to an increase in demand for oranges due to a fall in prices.