For most normal goods the income effect and the substitution effect work in the same direction; so when the price of a good falls, both the income and substitute effects lead to a higher quantity demanded. How would this change if the good is an inferior good?

Question

Business

Jolie Harper

7 June, 01:30

For most normal goods the income effect and the substitution effect work in the same direction; so when the price of a good falls, both the income and substitute effects lead to a higher quantity demanded. How would this change if the good is an inferior good?

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Answers (1)

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Stud · Answer 1

The income effect and substitution effect work in opposite directions and income effect is dominant.

Explanation:

In case of a normal good, both the income effect as well as substitution effect work in the same direction. A fall in the price of a product will increase the purchasing power of the consumer so its quantity demanded will increase.

The consumers will also prefer the cheaper good so the substitution effect will cause the quantity demanded to increase.

In case of an inferior good, however, income elasticity is negative. The income effect and substitution effect work in opposite directions.

A price decrease in the case of an inferior good will increase the real income and purchasing power of the consumer. This will cause the quantity demanded of the inferior good to decline as the consumer will prefer a substitute normal good.