Income and substitution effect

 INCOME & SUBSTITUTION  EFFECT 

INCOME  EFFECT 

The income effect, in Microeconomics is

the resultant change in demand for a good or service caused by an increase or decrease in a consumer's purchasing power of real Income As one's income grows, the income effect predicts that people will begin to demand more (and vice-versa).

So-called normal goods will exhibit this typical pattern. Inferior goods, on the other hand, may see their demand actually fall as income increases. An example of such an inferior good could be store-brand items: as people become wealthier they may opt instead for more expensive name brands

Understanding the Income Effect

The income effect is a part of consumer choice theory—which relates preferences to consumption expenditures andre consumer  demand curvethat expresses how changes in relative market prices and incomes impact consumption patterns for consumer goods and service when real consumer income rises, consumers will demand a greater quantity of goods for purchase

SUBSTITUTION  EFFECT 

It is in the decrease in sales for a product that can be attributed to consumers switching to cheaper alternatives when its price rises. A product may lose market share for many reasons, but the substitution effect is purely a reflection of frugality. If a brand raises its price, some consumers will select a cheaper alternative. If beef prices rise, many consumers will eat more mutton. 

In general, when the price of a product or service increases but the buyers income stays the same, the substitution effect kicks in. This is not only evident in consumer behavior. For example, a manufacturer faced with a price hike for an essential component from a domestic supplier may switch to a cheaper version produced by a foreign competitor.

How, then, does any company get away with increasing its price? In addition to the substitution effect, there's the income  effect some of its customers may be enjoying an increase in spending power and be willing to buy a pricier product. A company's success in repricing its product is determined in part by how much of the substitution effect is offset by the income effect.