Question

Explain with the help of diagrams.the effect of the following changes on the demand of a commodity.(1) A rise in the price of complementry goods.(2) A rise in the price of subsitute goods.

Answer 1

The substitution effect refers to the change in demand for a good as a result of a change in the relative price of the good compared to that of other substitute goods for example when the price of a good rises it becomes more expensive relative to other goods in the market and the increase in demand causes excess demand to develop at the initial price to excess demand will cause the price to rise and as price rises producers are willing to sell more thereby increasing output.