The change of relative prices is the substitution effect steep line to dotted line and the change of purchasing power is the income effect dotted line to parallel solid line what is the income effect. Income effect and substitution effect are the components of price effect i e.
Substitution effect and income effect.
Income effect and substitution effect. The income effect is a result of income being freed up whereas substitution effect arises due to relative changes in prices. The income effect expresses the impact of increased purchasing power on consumption while the substitution effect describes how consumption is impacted by changing relative income and prices. The decrease in quantity demanded due to increase in price of a product.
Income effect shows the impact of rise or fall in purchasing power on consumption. On the contrary substitution effect reflects the change in the consumption pattern of an item due to change in prices. Income effect arises because a price change changes a consumer s real income and substitution effect occurs when consumers opt for the product s substitutes.
The income effect is the change in consumption patterns due to a change in purchasing power.