Question

Explain in words, in one paragraph, what the income and the substitution effects of a price...

Explain in words, in one paragraph, what the income and the substitution effects of a price decrease are. Then show in a diagram the income and substitution effects of a price decrease for a normal good. Label your diagram carefully, and explain in a couple of sentences what the diagram shows.

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Answer #1

When the price of a normal good decrease, real income (M/P) increases so people demand more. This is called income effect that is demand for the normal good is increased for increased purchasing power.

Substitution effect means when the price of a normal good deceases people will substitute other expensive goods with that cheaper good.

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