# Substitution effect and income effect

Preis und Nachfrage eines Guts beeinflussen sich unweigerlich und direkt. Sie sind untrennbar voneinander abhängig. Entsprechend der Slutsky-Zerlegung wird hierbei zwischen dem Substitutionseffekt und dem Income effect unterschieden. Diese treten in der Regel parallel zueinander auf und bewirken einen berechenbaren Gesamteffekt, der sich positiv oder negativ auf die Nachfrage eines Guts auswirken kann.

## Substitution effect

One speaks of a so-called substitution effect when demand changes accordingly as a result of a change in the price of a good. If the price of a product is lowered, for example, this can mean that a potential buyer will decide to buy more often than before. As a result, the demand for this product is increasing. Such behavior speaks for the occurrence of the substitution effect.

## Income effect

The income effect usually occurs parallel to the substitution effect. It describes the demand for a good in relation to the real income of the buyer. The level of real consumer income can thus increase or decrease the demand for a particular product.

If, for example, the price of a product falls, this arithmetically increases the real income of the buyer. This financial difference can then have a positive effect on the demand for the lower-priced product and other products (which the buyer can afford because of the savings).

Conversely, however, it also means that if the price of a product increases and the real income of consumers remains unchanged, this will inevitably have negative effects on the demand for this and possibly other goods. This is known as the "law of demand". However, it says nothing about the extent to which the consumption of goods is falling.

## Overall effect

In the overall effect, both the substitution and income effects are considered together. Corresponding calculations can be used to determine whether there is a positive or negative overall effect on demand. This allows price changes of goods to be analyzed and evaluated in detail.

Economists like to use this method to analyze consumer behavior as soon as there are changes in pricing in their environment.

## Summary

• The substitution effect and the income effect usually occur in parallel
• both effects produce a predictable overall effect
• The overall effect has a positive or negative effect on the demand for a good
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