The change in the relative price—the price of one good relative to the prices of other goods—causes the substitution effect

Question

The change in the relative price—the price of one good relative to the prices of other goods—causes the substitution effect 

 

Answer 1

That's true. Let;s say two goods are substitutes.  As far as at least some consumers are concerned.  the two goods perform the same function for them, so either will do.

 

The price of Good A goes up.  The price of good B stays the same.  Now, Good A is relatively more expensive than good B. At least some consumers will switch from A to B.  They substitute. The market demand curve for A will shift to the left, and the market demand curve for B will shift to the right.

 

It works the other way too. If the price of B goes up and the price of A stays the same, then some consumers will substitute by buying A instead of B.

 

Similar effects will occur with price decreases for A or B.

 

There is another kind of substitution effect that occurs when incomes decrease or there is inflation.  Consumers will switch to less expensive alternatives.  

 

 

 

 

 

Answer 2

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