Substitution Effect

The substitution effect is the change in the quantity demanded of a good or service caused by a change in its price relative to the price of other goods or services. For example, if the price of apples increases, consumers may substitute oranges for apples.

The substitution effect is one of the two effects that determine the demand for a good or service. The other effect is the income effect. The income effect is the change in the quantity demanded of a good or service caused by a change in the consumer's income.

The substitution effect and the income effect can work in opposite directions. For example, if the price of apples increases, the substitution effect will cause consumers to substitute oranges for apples. However, the income effect will cause consumers to buy less of both apples and oranges because they have less money to spend.

The net effect of the substitution effect and the income effect on the demand for a good or service depends on the relative strength of the two effects. If the substitution effect is stronger than the income effect, the demand for the good or service will decrease. If the income effect is stronger than the substitution effect, the demand for the good or service will increase.

The substitution effect is an important concept in economics because it helps to explain how consumers make decisions about what to buy. The substitution effect also plays a role in determining the price of goods and services.