substitutieeffect

Substitutieffect is a concept in consumer theory that describes how a change in the price of a good leads to a change in the quantity demanded due to a shift in relative prices, while the consumer’s overall level of satisfaction (utility) is held constant. It captures the idea that, when one good becomes relatively more expensive, people substitute toward relatively cheaper alternatives.

The effect is best understood through compensated demand (Hicksian demand), which traces choices on a fixed indifference curve after a price change. Practically, economists decompose the total price effect into the substitution effect and the income effect. The substitution effect keeps utility constant by adjusting real income so the consumer can reach the same level of satisfaction, then observes how quantities change as relative prices shift. The income effect reflects the change in purchasing power caused by the price change and how this altered purchasing power influences quantities.

The Slutsky decomposition formalizes this decomposition: the total change in quantity demanded from a price change equals the substitution effect plus the income effect (the latter depends on the change in real income). The substitution effect for the good whose price changes is typically negative when its own price rises, as consumers substitute away from the now more expensive good. The total effect can be more or less negative, or even positive in unusual cases such as Giffen goods, where the income effect dominates the substitution effect.

Historically, the substitution effect was formalized in the early 20th century by Slutsky and later refined by Hicks. It remains a foundational tool for analyzing demand elasticities and consumer choice.