Price Effect
Price effect shows the total effect on consumer’s demand for a commodity due to change in the price of the same commodity, other things being equal. When the price of the good changes a consumer will be either off or worse off than before, depending upon whether the price fall or raises. Price effect has two components:
1. Substitution Effect: Substitution effect refers to the change in the amount of goods purchased due to the change in their relative prices alone, keeping real income and constant.
The substitution of relatively cheaper goods for a relatively expensive good is called the substitution effect. While the substitution effect changes consumption patterns in favor of the more affordable alternative, even a modest reduction in price may make a more expensive product more attractive to consumers.
For example, if hotel-A increases the prices of their items by 10% than that of hotel-B then people shift from hotel-A to hotel-B. The same effect applies across brands, goods, and even categories of goods. Examples here are Pepsi vs. Coke, Clothes vs. Entertainment.
2. Income Effect: It is the effect the consumer’s equilibrium caused by the change in his income if relative prices remain constant. The income effect can be both direct and indirect. When a consumer chooses to make changes to the way he or she spends because of a change in income, the income effect is said to be direct. An income effect becomes indirect when a consumer is faced with making buying choices because of factors not related to her income.
Income Consumption Curve (ICC)
Curve showing points of equilibrium at the various level of consumer income given constant product price is called as income consumption curve.
Negative Income Consumption Curve
In the case of inferior goods, ICC is negative showing a decrease in the quantity demanded of a good with the increase in the consumer income.
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