Economic forces, which determine the level of prices, supply and demand in the market, can be very different. In some cases, their action may predetermine the emergence of so-called income and substitution effects. They can be observed in the most different areas business. What is the essence of the noted effects? How can they interact with each other?
The essence of income and substitution effects
What are the income effect and the substitution effect? Let's consider their specifics one by one.
The income effect, according to a common definition, is an impact on the structure of consumer demand through a change in the purchasing power of the buyer, which is also accompanied by an adjustment in the price of a particular public good. That is, as soon as the cost of a product decreases, a person is able to purchase more of the corresponding products, while he still has cash also for the purchase of other goods. The income effect occurs in the following case - if one or another supplier offers a product cheaper than a competitive one.
In turn, the substitution effect is an indicator characterizing a change in the structure of demand, accompanied by the desire of buyers to make cheaper purchases for typical product items.
The income effect is a criterion that reflects how the amount of demand is affected by a change in the buyer’s level of solvency. The fact is that a person can use the freed up funds - due to the reduction in price of some goods - to purchase other products, thereby creating additional demand in the relevant sales segments. The income effect and the substitution effect can be considered in the same context. These economic phenomena can be observed simultaneously.
So, the income effect is characterized by a reduction in the price of goods, as a result of which the buyer, while maintaining the stability of his income, frees up additional funds, which he directs to purchase more corresponding benefits that have become more accessible, or for the purchase of other products. The price of a product falls - a person receives a certain “artificial income”, as if his salary had increased, after which he can spend it as he sees fit.
The substitution effect is characterized by the appearance on the market of cheaper goods of those categories that are familiar to a person, and he begins to purchase them, often refusing to purchase previous products and replacing them with more affordable ones. Let us study the features of the noted economic phenomena in more detail.
Specifics of the income effect
So, the income effect assumes that a person gets the opportunity to buy a larger volume of a good (due to an adjustment in its price) or use the freed-up funds to purchase other goods. This stimulates overall demand in the market. Discussions arise among economists about the impact of the corresponding trend on market capitalization.
On the one hand, in absolute terms, the amount of funds available to the buyer does not change. On the other hand, those companies that receive revenue from the released “artificial income” of a person and the intensification of his purchasing activities in the relevant segments have the opportunity to develop further, increase their capitalization, in particular, due to new investments and loans that can be attracted in growing business. Thus, externalities observed in the market and income effects may well be predetermined.
Specifics of the substitution effect
Let us now consider in more detail the specifics of the second trend. The substitution effect suggests that the structure of a person's consumer demand changes in favor of choosing cheaper goods. At the same time, it is assumed that the product familiar to him, for one reason or another, is increasing in price. The result is a decrease in demand for more expensive goods.
In some cases, substitution occurs between products of a similar group, but not identical. For example, a person may like apples and plums equally. If prices for the first type of fruit begin to rise, a person can buy them less often, while at the same time buying more plums if their cost does not change so noticeably or remains the same. Thus, apples are being replaced by plums in the consumption structure.
How can a corresponding trend affect the economy? Expert assessments regarding the phenomenon under consideration can also be very different. On the one hand, the revenue of companies that, relatively speaking, produce apples may decrease significantly due to the fact that buyers' priorities change and they begin to actively purchase plums. On the other hand, according to economists, an increase in prices for apples often becomes the reason for the excess demand for them. In this sense, the revenue volume of companies selling this type fruit may not decrease at all.
Thus, the substitution effect can be assessed, on the one hand, as a negative economic trend (if the apple supplier is forced to raise prices, for example, due to difficulties in the corporate business model and lack of liquidity), on the other hand, as a neutral or even positive, since the increase in the selling price of fruits may be due to just too much demand for them.
Relationship between effects
The substitution effect and the income effect that we are considering tend to actively interact. The content of relevant communications depends on the specifics of a particular product. It is quite possible that both effects can be cumulative, since the reduction in price of some goods, as a rule, leads to an increase in the intensity of demand for them.
The cyclical nature of the substitution effect
Consider the example of apples and plums again. Let’s assume that the former have become more expensive, and the demand for the latter has increased accordingly. A situation may well arise in which in one market or another (for example, if we are talking about a particular city) there will simply be a rush demand for plums. And this, in turn, will predetermine an increase in prices for them. After this, the selling price of plums may increase, after which buyers’ expenses for purchasing these fruits may reach the same level as if they were buying apples. After this, people who have, in principle, the same preferences can again modify the structure of their consumption, in which the intensity of purchasing apples becomes equal to the corresponding indicators for plums. Thus, in in this case There is a certain cyclical nature of the substitution effect.
When one effect gives way to another
In turn, due to the fall in demand for plums due to the fact that buyers are starting to spend more on apples, prices for the corresponding fruits are falling again. And here it is precisely the income effect that takes place. A person who is accustomed to spending, relatively speaking, 100 rubles a day on apples and plums, observes that expenses on the second type of fruit have fallen, let’s agree that by 30 rubles. This amount of money is released, after which the buyer may decide to use it to purchase more plums, apples or other fruits. Thus, we can observe a situation where one effect is gradually replaced by another.
Another scenario is also possible. There are products that are divided depending on quality and other parameters, for example, size or color, into “prestige” categories - economy class, mid-price, and premium products. A person, depending on his income level, can buy goods from each of the marked categories, but in a certain proportion. If he has a high salary, then premium products will be more common in his consumption structure. If the buyer’s income is low, then the frequency of purchases of goods highest quality his will most likely be incomparably lower.
Consumer preference factor
An interesting trend may emerge in the market. Let's consider it using the example of different varieties of apples. Suppose the market sells top quality, medium and low quality fruits. Let us also agree that the apple consumer has average income. Having received a salary, he first actively buys fruits of the highest quality, after he has less money, he moves to the middle price category, and by the time of the next salary he begins to purchase the cheapest apples.
Situation: on the market retail sales A new supplier of fruits is coming out, capable of offering, albeit not very high-quality fruits, but extremely cheap ones. A person who really loves apples, the moment he purchases them from a new supplier, sees that his cash is freed up. As we know, the income effect occurs when such situations arise, that is, when the buyer receives “artificial” revenue. A person, having discovered more free cash, will, of course, use it to purchase fruits premium- because he is a big fan of apples.
Thus, we see a “net” income effect, and it looks quite interesting. It would seem: one product is becoming cheaper, and the worst kind, but there is a growing demand for another - one of better quality. We can observe how significant a factor the existing model of a person’s consumer preferences becomes. If he were not an apple lover, he would probably buy them when necessary (for example, to add to a pie), focusing on the price, and not on the variety. But since in our example the citizen has a great craving for apples, he will buy the highest quality ones based on the freed up income. The greatest income effect, therefore, can be observed in purchasing behavior characterized by pronounced consumer loyalty to quality goods.
Labor market: income effect
Let us note that the economic trends we have considered can be observed not only in the retail sales segment, but also in other areas of business. Thus, it is quite possible to observe the effect of income and substitution on the labor market. Let's look at an example.
Let’s say a factory has opened in a small town to produce refrigerators and washing machines. The company created several hundred vacancies and hired workers from among the residents of the corresponding locality. At the same time, the local polytechnic institute launched training for engineers using programs adapted for technological processes, characterizing the assembly of refrigerators and washing machines.
After 5 years, the university produced its first graduates who were ready to find work at the plant. The management of an enterprise that assembles refrigerators and washing machines decided to take advantage of the opportunity to attract graduates for a small salary and published a list of relevant vacancies. However, polytechnic graduates were in no hurry to find employment, since compensation established size didn't suit them. The company, which managed to acquire investors and invested in increasing the capacity of factory lines opened for new vacancies, was forced to slightly increase salary offers.
Some polytechnic graduates agreed to work for an appropriate level of compensation, and the vacancies were partially filled. For some time, other engineers tried to find work at other enterprises in the city, but were unable to, since their specialization was adapted to the production of refrigerators and washing machines. As a result, they agreed to go to work at the plant even at the low salary that was initially offered.
The enterprise, which did not have to increase the salaries of the “second echelon” engineers to the level of the “first”, freed up funds. There was an income effect on the labor market. The company was able to spend the corresponding proceeds for purposes related to business development, in particular, for the modernization of production.
Labor market: substitution effect
Let's consider another scenario. Engineers with appropriate qualifications from other regions of the country began to flock to a small town with a thriving factory producing refrigerators and washing machines, hoping to get a job. high paying job. Since there were always vacancies in a growing enterprise, and new ones were opened if necessary, engineers were easily employed. For many of them, the salary offered by the company was considered quite decent (and it was also growing). But gradually more and more engineers came to the city.
The company, opening new vacancies, could no longer afford to hire new engineers at high salaries. But as competition grew between them, many specialists agreed to a lower one - and new workshops began to open at the plant, in which labor compensation was less than in the old ones. Moreover, the salaries of “first echelon” engineers stopped growing, and in some production areas they even decreased. Dissatisfied specialists began to quit, and in their place the plant easily hired other, “competing” engineers. Thus, a substitution effect occurred. The company was able not to increase the cost of paying employees.
Moreover, if the labor supply of appropriate volumes is formed in the market, the income effect and the substitution effect may correlate. For example, if engineers from other regions of the country, seeing that salaries at the enterprise are not growing, stop coming to a small city. In this case, further business growth becomes questionable, since the company needs personnel for the opening factory lines. It is again forced to publish vacancies with high salary, for which regular indexing is guaranteed. As a result, engineers are moving to the city again - and salary offers throughout the enterprise are leveling out, but after some time in locality specialists will arrive and will definitely start dumping. After this, the plant will again be able to benefit from the income effect.
Universal indicator
The most interesting thing is that in the case of the labor market, a situation similar to that which we examined using the example of premium apples and those characterized by low quality may be observed. This is possible if, relatively speaking, the polytechnic institute opens a program industrial practice, in which students will be sent to work at a factory for half their salary. The company, having saved on relevant vacancies, will be able to open more positions for the most highly qualified engineers and hire them.
So, regardless of the market segment, the income effect occurs in the following case: if among competitive offers one becomes cheaper, after which the buyer receives “artificial revenue”, which can be used for certain purposes. The substitution effect occurs if any of the competitive offers becomes more expensive - in this case, the buyer will prefer to purchase the product or services (if we talk about the labor market) from an alternative supplier or from another social group, if we are talking about engineers from the example we discussed above.
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The substitution effect is that when the price of a good changes, real income may remain unchanged, but the structure of demand will change. When prices rise, the consumer usually replaces the consumption of an expensive product with a cheaper one.
Substitution effect: A decrease in the price of a product (strawberries) means that it is now cheaper relative to all other goods. Strawberries become a more attractive product relative to others.
The substitution effect is expressed in the fact that at a lower price, a person has an incentive to purchase a cheap product instead of similar products that are now relatively more expensive.
The substitution effect can be easily understood by referring to the utility maximization rule.
The substitution effect, combined with the income effect, forms the overall price effect, which together causes a negative slope in the demand curve for goods and services. In Fig. Figure 3.21 shows the relationship between the above effects.
The effect of replacing hydrogen with me; tyl group depends on the degree of participation of the nucleophile in the transition state. A large CH - /H - rate ratio can be expected if the solvent participation in the unsubstituted compound is small. If the participation of the nucleophile is significant, the ratio will decrease because the favorable electronic effect of the methyl group is reduced by the steric effect preventing the participation of the nucleophile.
This substitution effect is qualitatively the same as when changing the heat of fusion when hydrogen in ethylenes is replaced by methyl groups: for example, CH2CH2, - 32 82; CH3CH CH2, - 30 12; trans - CH3CH CHCH3, - 27 62, where the increments are 2 7 and 2 5 kcal / mol.
If the substitution effect outweighs the output effect, then a decrease in the price of capital will lead to a decrease in the demand for labor. If the opposite is true, then the demand for labor will increase. If the substitution effect outweighs the output effect, then a change in the price of the substitute resource causes an equal change in the demand for labor. If the output effect exceeds the substitution effect, then a change in the price of a substitute resource causes an opposite change in the demand for labor.
Using the substitution effect and the production effect, explain how a decrease in the price of resource A can cause an increase in the demand for substitute resource B.
Here, the effect of dielectric substitution prevents the deposition of particles with e2 e1 onto the internal electrode; which leads to the formation of loose and flowing coatings.
The presence of a substitution effect in functional groups only slightly complicates the enumeration task. In this case, it is enough, in addition to the types of units, to distinguish between their types (see Section II. The energy of the molecule depends.
In addition to the substitution effect, high taxation forces companies to look for forms of remuneration that are not related to the payment of money and are difficult to tax.
According to the substitution effect, the consumer will buy more products whose price has decreased and replace them with other products that have become relatively more expensive. For example, a decrease in chicken prices (or a slower price increase) will cause us to buy more chicken compared to beef or pork.
Income effect (Income effect) - the impact exerted on the structure of consumer demand due to a change in his real income caused by a change in the price of the good.
The essence of this effect is that when the price of a good decreases, a person can buy more of this good without denying himself the acquisition of other goods. The income effect reflects the effect on the quantity demanded of changes in the buyer's real income. A fall in the price of one product has, even if only slightly, an impact on general level prices and makes the consumer relatively richer, his real income, albeit slightly, grows. Mine additional income received as a result of a reduction in the price of a given good, he can use it both to purchase additional units of it and to increase the consumption of other goods.
For example, when the price of meat decreases from 200 to 100 rubles. per kg. a person on his income of 10,000 rubles. can instead of 50 kg. buy already 100 kg. If he wants to maintain the level of consumption and continues to buy 50 kg. meat, then he can use the remaining funds to buy other goods, which will make him richer. As a result, demand will increase.
Substitution effect
Substitution effect (Substitution effect) - a change in the structure of consumer demand as a result of a change in the price of one of the goods included in the consumer set.
The essence of this effect comes down to the fact that when the price of one good rises, the consumer reorients himself to another good with similar consumer properties, but with the same price. In other words, consumers tend to substitute cheaper goods for more expensive ones. As a result, the demand for the original good falls.
For example, coffee and tea are substitute goods. When the price of coffee increases, tea becomes relatively cheaper for consumers and they will substitute it for relatively more expensive coffee. This will lead to increased demand for tea.
Relationship between the income effect and the substitution effect
The income effect and the substitution effect do not act in isolation, but in interaction with each other.
For normal goods the income effect and the substitution effect are summed up, since a decrease in the price of these goods leads to an increase in demand for them.
For example, a consumer, having a given income that does not change, purchases tea and coffee in a certain ratio, which are normal goods. In this case, the substitution effect works as follows. A fall in the price of tea will lead to an increase in demand for it. Since the price of coffee has not changed, coffee now becomes relatively (comparatively) more expensive than tea. A rational consumer replaces relatively expensive coffee with relatively cheap tea, increasing demand for it. The income effect is manifested in the fact that a decrease in the price of tea made the consumer somewhat richer, i.e. led to an increase in his real income. Because the higher the income level of the population, the higher the demand for normal goods, and the increase in income can be directed towards purchasing additional amounts of tea and coffee. Consequently, in the same situation (a fall in the price of tea while the price of coffee remains unchanged), the substitution effect and the income effect lead to an increase in the demand for tea. The income effect and the substitution effect act in the same direction. For normal goods, the effects of income and substitution explain the increase in demand when prices fall and the decrease in demand when prices rise. In other words, the law of demand is fulfilled.
For low category goods the effect of income and substitution effects is determined by their difference.
For example, a consumer, having a given income, purchases natural coffee and a coffee drink, which is a lower category product, in a certain ratio. In this case, the substitution effect works as follows. A fall in the price of a coffee drink will lead to an increase in demand for it, since the drink is now a relatively cheap good. Since the price of coffee has not changed, coffee is a relatively (relatively) expensive good. A rational consumer replaces relatively expensive coffee with a relatively cheap coffee drink, increasing the demand for it. The income effect is manifested in the fact that a decrease in the price of a coffee drink made the consumer somewhat richer, i.e. led to an increase in his real income. Since the higher the level of income of the population, the lower the volume of demand for inferior goods, the increase in real income of the consumer will be directed to the purchase of additional quantities of coffee. As a result, a decrease in the price of a coffee drink (lower category product) will lead to a fall in demand for it and an increase in demand for coffee (higher category product). Consequently, in the same situation (a fall in the price of a coffee drink while the price of coffee remains unchanged), the substitution effect leads to an increase in the demand for a coffee drink, and the income effect leads to a fall in demand for it. The income effect and the substitution effect operate in different directions.
and not individually, but in certain sets. Set of benefits- a set of certain quantities of various goods consumed together in a certain period of time. A change in the price of one good, with the prices of other goods remaining constant, is relative change in the price of a given good. In other words, this good becomes cheaper (or more expensive) in relation to other goods. In addition, a change in the price of a good leads to a change in the real income of the consumer. Before the price reduction of a given good, the consumer could purchase a smaller quantity of it, and after the price reduction, a larger quantity. He can also use the saved money to purchase other goods. A change in the price of a certain good affects the structure of consumer demand in two directions. The volume of demand for a given good changes under the influence of changes in its relative price, as well as under the influence of changes in the real income of the consumer.
Any change in price results in income and substitution effects because it changes the amount of goods available and their relative prices. The named effects are consumer reaction to changes in relative prices and real income.
Substitution effect
Definition 1
Substitution effect- a change in the structure of consumer demand as a result of a change in the price of one of the goods included in the consumer set.
The essence of this effect comes down to the fact that when the price of one good rises, the consumer reorients himself to another good with similar consumer properties, but with a constant price. In other words, consumers tend to replace more expensive goods with cheaper ones. As a result, the demand for the original good falls. For example, coffee and tea are substitute goods. When the price of coffee increases, tea becomes relatively cheaper for consumers and they will substitute it for relatively more expensive coffee. This will lead to increased demand for tea.
Income effect
[Definition] Income effect- the impact exerted on the structure of consumer demand due to a change in his real income caused by a change in the price of a good.
The essence of this effect is that when the price of a good decreases, a person can buy more of this good without denying himself the acquisition of other goods. The income effect reflects the effect on the quantity demanded of changes in the buyer's real income. A fall in the price of one product has, albeit insignificantly, an impact on the general price level and makes the consumer relatively richer; his real income, albeit insignificantly, grows. He can use his additional income received as a result of a reduction in the price of a given good both to purchase additional units of it and to increase the consumption of other goods.
Product categories
Depending on the buyer’s reaction to the growth of real income, all goods are divided into three categories:
- Normal goods
- Low category goods
- Giffen Goods
For normal goods, the income effect and the substitution effect are summed up, since a decrease in the price of these goods leads to an increase in demand for them.
Example 1
For example, a consumer, having a given income that does not change, purchases tea and coffee in a certain ratio, which are normal goods. In this case, the substitution effect works as follows. A fall in the price of tea will lead to an increase in demand for it. Since the price of coffee has not changed, coffee now becomes relatively (comparatively) more expensive than tea. A rational consumer replaces relatively expensive coffee with relatively cheap tea, increasing the demand for it. The income effect is manifested in the fact that a decrease in the price of tea made the consumer somewhat richer, that is, it led to an increase in his real income. Because the higher the income level of the population, the higher the demand for normal goods, and the increase in income can be directed towards purchasing additional amounts of tea and coffee. Consequently, in the same situation (a fall in the price of tea while the price of coffee remains unchanged), the substitution effect and the income effect lead to an increase in the demand for tea.
The income effect and the substitution effect operate in the same direction. For normal goods, the effects of income and substitution explain the increase in demand when prices fall and the decrease in demand when prices rise. In other words, the law of demand is fulfilled.
Example 2
For example, a consumer, having a given income, purchases natural coffee and a coffee drink, which is a lower category product, in a certain ratio. In this case, the substitution effect works as follows. A fall in the price of a coffee drink will lead to an increase in demand for it, since the drink is now a relatively cheap good. Since the price of coffee has not changed, coffee is a relatively (relatively) expensive good. A rational consumer replaces relatively expensive coffee with a relatively cheap coffee drink, increasing the demand for it.
The income effect is manifested in the fact that a decrease in the price of a coffee drink made the consumer somewhat richer, that is, it led to an increase in his real income. Since the higher the level of income of the population, the lower the volume of demand for inferior goods, the increase in real income of the consumer will be directed to the purchase of additional quantities of coffee. As a result, a decrease in the price of a coffee drink (lower category product) will lead to a fall in demand for it and an increase in demand for coffee (higher category product). Consequently, in the same situation (a fall in the price of a coffee drink while the price of coffee remains unchanged), the substitution effect leads to an increase in the demand for a coffee drink, and the income effect leads to a fall in demand for it. The income effect and the substitution effect operate in different directions.
For goods of the lowest category, the resultant of both effects depends on the degree of impact of each of them on consumer choice. If the substitution effect is stronger than the income effect, then the demand curve for an inferior good will have the same shape as a normal good. Thus, the law of demand is fulfilled. If the income effect is stronger than the substitution effect, then the volume of demand for a lower-category good falls as the price of this good decreases. In other words, the law of demand does not apply here. Products for which the law of demand does not hold are called Giffen goods, named after the English economist of the 19th century, who theoretically substantiated this phenomenon. The Giffen demand curve for goods is shown in the figure.
Figure 1. Giffen demand curve for goods
Definition 2
Giffen product- a product for which demand, other things being equal, changes in the same direction as its price, since the income effect is stronger than the substitution effect.
Let's assume that $X$ is a low-quality product. The income effect and the substitution effect work in the opposite direction. The income effect reduces the substitution effect. As a result, the total effect on demand is the difference between the substitution effect and the income effect:
Figure 2.
In this case, the overall effect is not so significant, which means that the price elasticity of demand is quite low:
Figure 3.
If a low-quality product occupies a large place in the consumer’s budget, then a decrease in Px leads to the fact that the negative income effect will cover the positive substitution effect and the overall effect will be expressed in a decrease in demand for product $X$.
The consumer most often uses goods not individually, but in certain sets. Set of benefits- a set of certain quantities of various goods consumed together in a certain period of time. A change in the price of one good, with the prices of other goods remaining constant, represents a relative change in the price of that good. In other words, this good becomes cheaper (or more expensive) in relation to other goods. In addition, a change in the price of a good leads to a change in the real income of the consumer. Before the price reduction of a given good, the consumer could purchase a smaller quantity of it, and after the price reduction, a larger quantity. He can also use the saved money to purchase other goods. A change in the price of a certain good affects the structure of consumer demand in two directions. The volume of demand for a given good changes under the influence of changes in its relative price, as well as under the influence of changes in the real income of the consumer.
Any change in price results in income and substitution effects because it changes the amount of goods available and their relative prices. These effects are the consumer's reaction to changes in relative prices and real income. Substitution effect- a change in the structure of consumer demand as a result of a change in the price of one of the goods included in the consumer set. The essence of this effect comes down to the fact that when the price of one good rises, the consumer reorients himself to another good with similar consumer properties, but with a constant price. In other words, consumers tend to substitute cheaper goods for more expensive ones. As a result, the demand for the original good falls. For example, coffee and tea are substitute goods. When the price of coffee increases, tea becomes relatively cheaper for consumers and they will substitute it for relatively more expensive coffee. This will lead to increased demand for tea. Income effect- the impact exerted on the structure of consumer demand due to a change in his real income caused by a change in the price of a good. The essence of this effect is that when the price of a good decreases, a person can buy more of this good without denying himself the acquisition of other goods. The income effect reflects the effect on the quantity demanded of changes in the buyer's real income. A fall in the price of one product has, albeit insignificantly, an impact on the general price level and makes the consumer relatively richer; his real income, albeit insignificantly, grows. He can use his additional income received as a result of a reduction in the price of a given good both to purchase additional units of it and to increase the consumption of other goods.
For normal goods the income effect and the substitution effect are summed up, since a decrease in the price of these goods leads to an increase in demand for them. For example, a consumer, having a given income that does not change, purchases tea and coffee in a certain ratio, which are normal goods. In this case, the substitution effect works as follows. A fall in the price of tea will lead to an increase in demand for it. Since the price of coffee has not changed, coffee now becomes relatively (comparatively) more expensive than tea. A rational consumer replaces relatively expensive coffee with relatively cheap tea, increasing demand for it. The income effect is manifested in the fact that a decrease in the price of tea made the consumer somewhat richer, that is, it led to an increase in his real income. Because the higher the income level of the population, the higher the demand for normal goods, and the increase in income can be directed towards purchasing additional amounts of tea and coffee. Consequently, in the same situation (a fall in the price of tea while the price of coffee remains unchanged), the substitution effect and the income effect lead to an increase in the demand for tea. The income effect and the substitution effect act in the same direction. For normal goods, the effects of income and substitution explain the increase in demand when prices fall and the decrease in demand when prices rise. In other words, the law of demand is fulfilled.
For low category goods the effect of income and substitution effects is determined by their difference. For example, a consumer, having a given income, purchases natural coffee and a coffee drink, which is a lower category product, in a certain ratio. In this case, the substitution effect works as follows. A fall in the price of a coffee drink will lead to an increase in demand for it, since the drink is now a relatively cheap good. Since the price of coffee has not changed, coffee is a relatively (relatively) expensive good. A rational consumer replaces relatively expensive coffee with a relatively cheap coffee drink, increasing the demand for it. The income effect is manifested in the fact that a decrease in the price of a coffee drink made the consumer somewhat richer, that is, it led to an increase in his real income. Since the higher the level of income of the population, the lower the volume of demand for inferior goods, the increase in real income of the consumer will be directed to the purchase of additional quantities of coffee. As a result, a decrease in the price of a coffee drink (lower category product) will lead to a fall in demand for it and an increase in demand for coffee (higher category product). Consequently, in the same situation (a fall in the price of a coffee drink while the price of coffee remains unchanged), the substitution effect leads to an increase in the demand for a coffee drink, and the income effect leads to a fall in demand for it. The income effect and the substitution effect operate in different directions.
For inferior goods, the net effect of both effects depends on the degree to which each influences consumer choice. If the substitution effect is stronger than the income effect, then the demand curve for an inferior good will have the same shape as a normal good. Thus, the law of demand is fulfilled. If the income effect is stronger than the substitution effect, then the volume of demand for a lower-category good falls as the price of this good decreases. In other words, the law of demand does not apply here. Goods for which the law of demand does not hold are called Giffen goods, named after the English economist of the 19th century who theoretically substantiated this phenomenon. The Giffen demand curve for goods is shown in the figure.
Giffen product- a product for which demand, other things being equal, changes in the same direction as its price, since the income effect is stronger than the substitution effect.
