Substitution Effect

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What is the 'Substitution Effect'

The substitution effect is the idea that as prices rise (or incomes decrease) consumers will replace more expensive items with less costly alternatives. Conversely, as the wealth of individuals increases, the opposite tends to be true, as lower-priced or inferior commodities are eschewed for more expensive, higher-quality goods and services - this is known as the income effect.

BREAKING DOWN 'Substitution Effect'

Although beneficial to some (i.e. discount retailers), in general, the substitution effect is very negative in nature, as it limits choice. This is true not only for products, but also for services. Examples of the substitution effect in action can sometimes be observed over the winter holiday season, where, in lean economic times, discount retailers often hold up well.

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RELATED FAQS
  1. What's the difference between the substitution effect and the income effect?

    Learn the difference between the income effect and the substitution effect in terms of spending money. Predict which direction ... Read Answer >>
  2. What's the difference between the substitution effect and price effect?

    Learn how the increase in an item's price affects consumer demand. Explore the differences between the substitution and price ... Read Answer >>
  3. What's the difference between the income effect and the substitution effect?

    Learn more about the income effect and substitution effect in economics. Find out how these two principles impact consumer ... Read Answer >>
  4. How do you calculate the income effect distinctly from the price effect?

    Learn more about how the income and substitution effects operate in economics. Find out how to separate either of these while ... Read Answer >>
  5. What's the difference between the income effect and the price effect?

    Learn what the price effect is and how it is related to consumer spending. Learn what two components make up the price effect ... Read Answer >>
  6. Is the substitution effect negative for consumers?

    Explore whether the substitution effect is positive or negative for consumers as well as for retailers, manufacturers and ... Read Answer >>
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