A substitution effect occurs when a price change motivates consumers to buy less of a high-priced product and replace it with a lower-priced one, without changing their overall spending. This is due to budget constraints and does not necessarily require products to be the same.
Sometimes known as a type of substitution swap, a substitution effect is a term used to describe how a price change affects consumers’ purchasing activity. This particular phenomenon is actually one of two distinct effects that can occur as a result of a price change. Typically, a substitution effect refers to situations where the consumer is motivated to buy less of a high-priced product and replace it with a product that costs less.
One of the factors involved with a substitution effect is the assumption that the consumer’s income level does not change. Only the price has changed. The implication is that if the price had remained at the previous level, the consumer would have had no motivation to make a change as he considered the previous price to be equal. Unlike the income effect, where the consumer’s income changes, this specific phenomenon focuses directly on the impact of price changes, causing consumers to change their buying habits so that they continue to receive the same amount without spending more money.
It is important to note that the substitution effect does not indicate that consumers simply stop buying the higher priced product. Instead, they reduce their consumption of that product while increasing their consumption of the lower-priced product. While the small price difference previously was not enough to motivate the consumer to try the lower-priced product, the increase in the price of the favored product made the savings more attractive and led to switching.
This is often related to budget constraints as consumers try to keep their spending within a specific range. For example, if the price of a particular brand of canned green beans increases from $0.75 per can to $1.00 per can, some consumers may be motivated to try a home or store brand priced at $ $0.50. Instead of buying four cans of the higher priced product, the consumer buys two cans of each brand, effectively offsetting the price increase and spending the same amount of money to buy the same amount of canned green beans.
Products do not need to be the same to trigger a substitution effect. All that is required is the need to partially replace the use of a product that now has a higher price tag with one that costs less. This means that if the price of hamburgers rises appreciably, a family can reduce beef consumption from four nights a week to three, while increasing consumption of the less expensive chicken. Another approach would be to increase vegetable consumption and reduce meat use at various meals throughout the week.
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