The substitution effect is what happens when something you buy gets too expensive, so you buy a cheaper alternative instead. Similarly, if you had to take a pay cut, you choose less expensive alternatives to compensate for a more expensive version you would’ve bought if you had more money.
Who needs a TV when you can just watch videos on your laptop? Who needs ice cream parlour ice cream when you can buy cheaper ice cream from the grocery store? Who needs (legal) pot from a dispensary when you can just buy the seeds and grow your own grass (again, if it’s legal)?
A more unconventional example: dog-people adopting a cat instead of a dog. Many people grow up with dogs, and feel themselves to be true dog-people. But with crushing student debt and apartment city living, many dog-people want a dog...but find owning a dog too expensive. Dogs take more time (time is money) and more space. Cats are easier to care for, and still make great companions (in their own way), making cats a substitute for dogs among many dog-people.
Related or Semi-related Video
Econ: What are Income and Substitution E...8 Views
And finance Allah shmoop what our income and substitution effects
Often people seemed set in their ways buying the same
coffee at the same price every day taking the same
bus at the same time every day buying you know
entertainment magazines every day and so on That is until
prices change or our pay changes like our salaries which
makes us then do a double take right Well the
income effect describes how a change in income changes a
consumer's demands Getting a pay raise increases purchasing power which
increases demand for goods and services while taking a pay
cut will lower purchasing power in consumer demand The substitution
effect describes how people substitute one good for another when
either prices income changes or a new rival good arrives
on the market For both the income in substitution effect
it's common that as income rises inferior goods are replaced
with normal goods which includes you know fancy luxury goods
Well inferior goods are goods whose demand decreases when income
rises Right like people want less of that crappy box
Rice and more of the freezer frozen expensive good rice
Normal goods are the opposite Demand increases for them as
income rises Like if we look att coffee in the
McDonald's coffee is an inferior good while Starbucks coffee is
a normal good rights more expensive more lavish more lugs
for getting a ride to work while busing is an
inferior service compared to getting a taxi If anyone drives
those things anymore or anywhere the richer we get the
more we spend in the more we switch out inferior
goods for normal goods For instance you're shopping for toilet
paper Yes we all do Last week's pay raise might
mean you stock up more on toilet paper like never
before using it to line your walls of your house
because well you can mo money mo tp write thie
income effect is then at work or your pay raise
might mean you buy the same amount of toilet paper
as before But you buy the super soft yet super
sturdy gold lined fancy toilet paper with the talcum powder
All in it Yes cream oblique soft to go with
your you know new golden toilet of course because you're
substituting your inferior toilet and toilet paper with a luxury
toilet and toilet paper We're looking at the substitution effect
but hold up Buying a gold toilet in gold lined
toilet paper because you've got a raise also falls under
the income effect umbrella since it's a change in your
consumption caused by a change in your income Yet the
income effect and substitution of facts can both apply to
the same situation So let's take a look at a
price change instead of any income change in this parallel
universe You did not get a raise Let's say the
gold lined toilet paper wasn't selling too well on the
market for some odd reason it kind of itches there
So it went on mega sale In fact the gold
lined toilet paper was cheaper than the toilet paper you
usually buy so you substitute your normal teepee with the
luxury TP Since your income stayed the same Well there's
no income effect to be found here and no gold
toilets Unfortunately this is another example of the substitution effect
at work Your favorite wine is a nice Napa Valley
cab cabernet there that usually retails for fifty bucks a
bottle Unfortunately California's hit by yet another set of wildfires
and half the inventory of your favorite wine is destroyed
prices skyrocket was fifty bucks a bottle Now it's one
hundred more than you're willing to pay for a bottle
of hooch So you switch to two buck chuck until
prices get back to normal So to recap the income
effect is changes in consumption based on changes in your
income More money more buying power which means greater demand
in the consumer market less money less buying power which
means lower demand in the market Whether the quantity or
quality of what you're buying changes doesn't make a whole
lot of difference is just a change in how much
you're spending We're talking about here Well the substitution effect
is when you switch out one good for another whether
from an income change or a price Change more money
or slashed prices while time to trade up less money
or prices than rose Well time to trade down And
then you get laid off from your job and have
to take a gig working at a call centre for
half your previous salary The dark side of the income
effect No more gold lined toilet paper for Gyu Instead
you're stealing TP from the bathroom at McDonald's trade in
that Cadillac you releasing Switch to a line scooter instead
Also no more sushi lunches Instead Gore buying canned tuna
in bulk at Walmart for ninety nine cents a serving
and brown bagging homemade tuna salad sandwiches toe work and
forget the weekly massages at the spa Yeah Instead you're
plunking quarters into the massage chair they have at the
malls here So good luck with that Yeah So those
are income and substitution effects there Yeah Pretty sexy or 00:04:52.519 --> [endTime] not What
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