The substitution effect is defined by sliding the budget line around a
fixed indifference curve; the income effect is defined by a parallel shift
of the budget line. The original budget line is at ab, and a fall in the price
of gasoline takes it to aj. The original utility-maximizing point is at
with of gasoline being consumed, and the new utility-maximizing
point is at with of gasoline being consumed. To remove the income
effect, imagine reducing the consumer’s money income until the original
indifference curve is just attainable. We do this by shifting the line aj
parallel (dashed) line nearer the origin that just touches the
indifference curve that passes through The intermediate point
divides the quantity change into a substitution effect and an income
effect
We can think of the separation of the income and substitution effects as
occurring in the following way. After the price of the good has fallen, we
reduce money income until the original indifference curve can just be
obtained. The consumer moves from point to an intermediate point
A
Q 0
A 2 Q 2a 1 j 1
A 0. A 1
Q 0 Q 1
Q 1 Q 2.A 0