PRICE EFFECT<br /> It is the change in demand, in response to a change in price of a commodity, other things remaining constant.<br />Other Things:<br /> Income of the consumer, Tastes and Preference of the consumer, Price of other goods. All these are treated to be constant. <br />
Proportionate change in Quantity demanded of x<br /> Proportionate change in Price of x<br /> Price Effect = <br />
It is said that Price Effect is the summation of two effects :<br /><ul><li>Substitution Effect.
Income Effect.</li></ul>PRICE EFFECT = INCOME EFFECT + SUBSTITUTION EFFECT<br />
TO DISCUSS THE COMPONENTS<br /> Every price change therefore can be decomposed into Income Effect and Substitution Effect.<br /><ul><li>SUBSTITUTION EFFECT :</li></ul> In this effect the consumer is forced to chose a product that is less expensive for maximizing his satisfaction as the nominal income of the consumer is fixed.<br />
INCOME EFFECT<br />The Income effect can be discussed for two types of commodities:<br /><ul><li>NORMAL GOODS : If there is a price fall real income increases due to which demand increases and vice versa.
INFERIOR GOODS : Due to an increase in real income demand decreases.
GIFFEN GOODS : Demand decreases when price decreases.</li></li></ul><li>