Income Effect and Substitution Effect

The effects associated with the demand Individual and market are widely studied within marketing, since it is fundamental in social aspects such as the economy. There are several components that are necessary to know before delving into these definitions since they are related to the modification of prices, the consumer and some other terms that we will know below to be able to define the income effect and the substitution effect.

These effects are very similar and often defined like each other, but it is important to correctly define each one of them to understand how they affect the economy, which is essential, especially in the study of markets.

What is the income effect?

All variation in demand quantity is defined as the income effect, provided it is linked to the

modification of purchasing power. This variant may have a different effect depending on the case, that is, when the price of a good or service increases purchasing power falls and when the opposite occurs, power increases purchasing.

The income effect is often explained by graphs in which two common goods vary and one of them remains constant in price while the other falls. This creates forces called the income effect and the substitution effect, which modify the habitual form of consumption.

What is the substitution effect?

Closely related to changes in the quantity of demand that occur as a result of a change in price of goods and services. A difference between the two effects can be established by mentioning that in the income effect the quantity of demand is affected by purchasing power.

Income effect and the consumer

This effect is linked to the consumer and to demand, which is defined in economics as the total amount of goods that people want to obtain. Price is another important point that has a close relationship between the consumer and the effect income, the most tangible negative consequences of which can be observed in the fall or rise of prices.

Acquisitive power

It is the relationship between the price that is paid for a quantity of products and the resources that are had to buy them is known as power acquisitive and although it is often seen as related to wages and workers, it is a concept that encompasses companies, countries and individuals equally.

Price effect

The price effect It is made up of the income effect and the substitution effect, since the change in prices causes the consumer to re-evaluate and modify the quantity of the products they consume.

Types of income effects

According to the amount of demand for a certain product by a group of people or company increases or decreases, it could be considered a negative or positive income effect and will be described below.

Negative income effect

Any change in purchasing power in which goods are less than income, will be negative and will have as consequently a modification of their consumption by people who in some cases will choose to buy less than same.

Positive income effect

A positive income effect can have as a consequence an increase in the consumption of said good, this occurs when the price of the products does not negatively affect the purchasing power of the consumers.

Zero income effect

Sometimes when income does not affect demand, it is said that the income effect is null, because said good could be independent of demand, therefore, not be affected by it.

Consequences

In marketing, the study of these effects is important, since it can help to better position a certain product in the market. Many consumers reject a product or service by increasing its price, which in turn has other consequences.

This affects the demand for said product, which was previously more consumed due to its lower price and which could now be rejected by consumers as their purchasing power is affected.

Other effects on the economy

The importance of purchasing power gains strength as free markets make their way more and more in the world every day. With the rise of the internet, the consumer has access to new forms of mass consumption, in which these effects are also visible. Stores like Amazon or Netflix today are a fundamental part of the supply and demand of entertainment, which in turn has caused a significantly negative effect on the way in which, for example, previously people consumed tv for cable.