Substitution Effect

Substitution effect measures change in the amount demanded of a commodity due to the commodity becoming cheaper or dearer in relation to the other.

a) If the price of a commodity falls:

It becomes cheaper compared to others.

Cheaper commodity is substituted for the other.

Thus, the demand for the commodity increases.

b) If the price of the commodity rises:

It becomes costlier compared to others.

Costlier commodity is substituted by others.

Thus, demand for the commodity reduces.

Fig 1: Price effect, income effect and substitution effect for a fall in price-rise in demand

Fig 2: Price effect, income effect and substitution effect for a rise in price-fall in demand

Fig 3: Establishing the law of demand for a “normal good”

Fig 4: Establishing the law of demand for a “inferior good”