Microeconomics: Income Effect vs. Substitution Effect?

Question

Can someone please explain to me the difference between these two so that I can actually understand it? When I look these two up in the text, it seems they are pretty much exactly the same. And I have to answer these 4 questions (To all of them, the answer is either A) Income Effect or B) Substitution Effect):

1. When the price of a product increases, a consumer is able to buy less of it with a given money income. This describes:(a or b)

2. When the price of a product rises, consumers shift their purchases to other products whose prices are now relatively lower. This statement describes:(a or b)

3. When product prices change, consumers are inclined to purchase larger amounts of the now cheaper products and less of the now more expensive products. This describes:(a or b)

4.The income and substitution effects account for:

a) the upward sloping supply curve.

b) the downward sloping demand curve

c) movements along a given supply curve

d) the "other things equal" assumption

Answer 1

I would advise you to study this from a chemists angle. Start studying wealth on the lines a chemist studies matter. Classify wealth in two broad classes: A) Wants comprising of goods and services and B) Means consisting of money and moeny related forms of wealth.

Remember this Law of Conservation. This is mother of all sciences: be it chemistry, be it economics, be it biology. At any given point of time,

Value of wants = Value of Means (the way credits equal debits in accounting).

If wants increase, may be due to increase in prices or increase in human need, any or all the tree mentioned below happen:

1) Cheaper wants substitute costlier wants (substitution effect)

2) Present wants are changed into future wants

3) Future means are changed into present means by availing loans or credit purchase or cashing long term investments to meet present wants.

Always remember that wants and means are forms of wealth. They can neither be created nor be destroyed but can be changed from one form to another and this is Law of Conservation.

Answer 2

The substitution effect is when the price of one good rises, and the consumer buys more of the cheaper good.

The income effect is when the consumer cuts back on all goods, not simply the good that has become more expensive.

1. A.

2. B.

3. B

4. B

Answer 3

100% agree with Mr. Econ.  

Use the Slutsky or Hicks decomposition to determine the change.