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Inferior Good in Income and Substitution Effects assignment help: Delving deep
Inferior Good in Income and Substitution Effects is an important concept in Finance. An increase in the price of a single good with customer preferences, income and cost of other goods being constant, has two important effects on the demand for that specific good:
In case of an inferior good, the Substitution effect and the Income effect will move in varied directions. However, the overall effect of a change in cost cannot be theoretically determined.
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Why is it important?
The Income and Substitution Effects theory is used to explain a fall in the cost of the inferior good and a rise in income. Indifference curves have to be carefully drawn to show an inferior good when one is drawing a two-good model with indifference curves and budget lines.
When a particular good is an inferior good, a reduction in its consumption is the effect of a rise in income. The substitution effect, when the price falls, is never perverse. It always results in higher demand. The income effect, in case of an inferior product, works in a direction that is opposite to the substitution effect. It is only when the substitution effect outbalances the income effect that there is an expansion in demand when there is a fall in prices.
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