Answer to Question #317228 in Microeconomics for Aniket

Question

For a downward sloping demand curve, the magnitude of substitution effect is always larger than a that of income effect

Answer 1

Consumer choice theory is greatly implicated by income effect and substitution effect. Income effect gives an expression to the impact of increased purchasing power on consumption based on consumer's income. On the other hand, the substitution effect describes how consumption is impacted by changing relative income and prices. It's encountered when consumers replace cheaper items with more expensive ones when their financial conditions change.

The magnitude of substitution effect is always larger than that of income effect because an increase in the consumer's income makes a shift from inferior goods to normal goods. For normal goods, an increase in consumers' real income, leads to demand for a greater quantity of goods for purchase, unlike inferior goods whose demand declines as real income for consumers rises and vice versa.