Question

State legislators recognize that a change in the price of school supplies has both a substitution effect and an income effect. How are the substitution effect and income effect different from each other? If school supplies are an inferior good and the price of school supplies increases, how does this impact the substitution effect and the income effect? What are the potential implications for the total effect of the price increase?

Answer 1

Income affect is associated with the income whenever income of the individuals increases the quantity demanded will also increases.When the price of school supplies is considered it has both income effect and substitution effect.Schools supplies has an income effect in the sense when the income of the individual increases the quantity demanded of the school supplies will also increases.When the individuals are left with more income they have more purchasing power and thus they can demand more.Considering the price effect on schools supplies the income effect explains how the price of a good affect the quantity demanded .Income effect states that when the price of school supplies decreases,the people are left with more income and more purchasing power and individuals will demand more of school supplies such as pen ,note book etc..A small reduction in price will attract the consumers.

Now when substitution effect is considered if the price of school supplies increases people will replace expensive products with the cheaper ones.Considering the school supplies like notebook,water bottle pen etc..there are various brands for these items.Some brands are expensive and some brands are cheaper .When the price of the school supplies increases in general individual will substitute expensive ones with cheaper ones.Hence the price of school supplies has both substitution as well as income effects.

If the school supplies are considered to be inferior and when the price of school supplies increases the individuals will buy more of school supplies because in the case of inferior goods the income effect dominates the substitution effect and it will lead the consumers to buy more of goods and less of substitutes.Thus when the price increases the individuals will purchase more of school supplies when school supplies are considered to be inferior.
But if the school supplies are considered to be normal good when the price increases the quantity demanded will decrease.