Tuesday, May 6, 2008

The Substitution Effect

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The substitution effect refers to the increase in the consumption of a product as its price decreases because some consumers will buy this product as a substitute for something else.


Hamburger Example of the Substitution Effect
Suppose you go to McDonald's for lunch. On the way there, you are thinking you might enjoy their chicken sandwich today.
When you arrive at the restaurant, you are pleasantly surprised to find that Big Macs are on sale for $1. The chicken sandwich is not on sale and costs $3.50.
Thus, when the price of Big Macs decreases, one of the reasons the quantity demanded increases is that some consumers will substitute away from other products (e.g., chicken sandwiches) and buy the cheaper Big Macs.

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