Question

Diagrammatically explain concepts of income effect, substitution effect and price effect. Also show the manner in which price effect can be split up into income and substitution effects.

Answer 1

Answer:

Explanation:

The effect of a change in the price of bread on the quantity demanded into what J.R. Hicks called the substitution effect and income effect. The substitution effect shows the change in the consumption of x which occurs when its price and hence the relative prices of x and y change.

Answer 2

Income, Substitution and Price effect explained with the help of graphical presentation. The Price effect depicts the combination of income and substitution effect.

Explanation:

• Income Effect represents purchasing power chasing prices of goods. A consumer is reluctant to price increase and thus buying power increases.

• Substitution Effect assumes, purchasing power as neutral. The increase in prices of goods, decreases the quantity bought.

• Price Effect is a combined effects of income and substitition wherein the point of intersection equalises consumer demand. (as shown in the graph with dotted lines)

Income, Price and Substitution effects:

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