Substitution Effect

AAA

DEFINITION of 'Substitution Effect'

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.

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  1. Marginal Rate of Substitution

    The amount of a good that a consumer is willing to give up for ...
  2. Economics

    A social science that studies how individuals, governments, firms ...
  3. Substitution Swap

    An exchange that is carried out by trading a fixed-income security ...
  4. Indifference Curve

    A diagram depicting equal levels of utility (satisfaction) for ...
  5. Asset Substitution Problem

    A problem that arises when a company exchanges its low-risk assets ...
  6. Fast-Moving Consumer Goods (FMCG) ...

    These are consumer goods products that sell quickly at relatively ...
Related Articles
  1. Why We Splurge When Times Are Good
    Personal Finance

    Why We Splurge When Times Are Good

  2. Navigating E-commerce: Alibaba, eBay ...
    Investing Basics

    Navigating E-commerce: Alibaba, eBay ...

  3. How is the stock market affected by ...
    Savings

    How is the stock market affected by ...

  4. As Boomers Slow Down, Will The Economy ...
    Investing News

    As Boomers Slow Down, Will The Economy ...

Hot Definitions
  1. Halloween Strategy

    An investment technique in which an investor sells stocks before May 1 and refrains from reinvesting in the stock market ...
  2. Halloween Massacre

    Canada's decision to tax all income trusts domiciled in Canada. In October 2006, Canada's minister of finance, Jim Flaherty, ...
  3. Zombies

    Companies that continue to operate even though they are insolvent or near bankruptcy. Zombies often become casualties to ...
  4. Witching Hour

    The last hour of stock trading between 3pm (when the bond market closes) and 4pm EST. Witching hour is typically controlled ...
  5. October Effect

    The theory that stocks tend to decline during the month of October. The October effect is considered mainly to be a psychological ...
  6. Repurchase Agreement - Repo

    A form of short-term borrowing for dealers in government securities.
Trading Center