Figure 6-3 Income and Substitution Effects of a Price Change
reduction in the price to In each case, the substitution effect (shown
by the green arrow) increases the quantity demanded. In each case there
is also an income effect (the red arrow), but the size and sign of the
income effect differs in each case. The sum of the income and substitution
effects determines the total effect of the price change and thus how
overall quantity demanded responds to the price reduction. Note that all
normal goods have negatively sloped demand curves. The same is true for
most inferior goods. The figure illustrates why in the case of an inferior
good the income effect must be very strong in order to generate a
positively sloped demand curve. This is a very rare case in economics, but
there is some interesting history behind it.
Demand curves for normal goods are negatively sloped. Demand
curves for inferior goods are negatively sloped unless the income effect
outweighs the substitution effect. In each of the diagrams, the initial
price is and the initial quantity demanded is Thus, A is a point on
p 1.p 0 Q 0.