1 Answer | Add Yours
What we are talking about here is what causes price elasticity of demand. When the price of one good goes up, what is the main cause of the drop in the quantity of that good that is demanded?
In general, the substitution effect is more responsible than the income effect. This is particularly true when we are talking about goods that do not take up a huge percentage of a person's income.
Let us say that chicken costs $1 per pound and beef costs $2 (not realistic numbers, I know). If beef rises to $3 per pound, I am still likely to be able to buy all the beef I want. I will not decrease my consumption dramatically because of this. However, the price of beef relative to chicken has really jumped here. All of a sudden, I can get 3 pounds of chicken for the price of one pound of beef where before I could only get 2. This is a much more significant change than the change in price relative to my income. It is much more likely to inspire me to buy chicken rather than beef.
Overall, then, the substitution effect has a greater effect than the income effect in changing quantity demanded in response to a change in price.
We’ve answered 318,980 questions. We can answer yours, too.Ask a question