Question

1. Know the difference between income and substitution effects.
   1. Define the income effect. ___________________________________
   2. Define the substitution effect. ________________________________

Answer 1

A) Income effect is talked about the effect on person's real income if there is changes in price.Income effect means purchasing power capacity when there is change in price.This can be positive and negative depend upon the circumstance.basically income effect refer the changes in the demand for a product caused by change in consumer disposable income.

Example if rice prices is decrease 30% then person real income is increases because now he can purchase more quantity.

B) Substitution effect means when when due to change in price of one goods the demand of substitute product is changes.If there will be increase in price of one goods it leads to increase in demand of substitute goods.when there is decrease in price of one comodity then substitute goods demand decrease.

Example - coffee and tea