Question

Explain the concept of substitution effect, while also providing an example(this must be an example of your life experience and be specific).

Answer 1

Substitution Effect is the change in demand for a good or service that results from change in price (relative price) of the good in terms of another good (substitute).

To elaborate, when the price of a good increases, the consumers will replace the more expensive good with a less costly alternative (a substitute good).

A good example of substitution effect from life experience is an increase in price of coffee when there is lower production of coffee plant. As coffee price increases, the immediate next substitute is tea. As a consumer, I have switched to consumption of tea when coffee prices have trended higher.

Another good example of substitution effect in real life that we generally experience is in food product such as meat. When the price of red mean trends higher, the demand for red meat declines. On the other hand, the demand for fish or chicken increases.

It is also important to note that when consumer income increases, there can be a substitution effect as well when the consumer shifts to higher price goods. Just as an example, as consumer income increases, the consumer might shift from a non-branded jeans to a branded jeans.