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chosen here, that will move
consumers from point A to point
C. Once again, that's
not labeled, but some lower
amount of potatoes.
That will move them from point
A to point C. So, ultimately,
they'll choose fewer potatoes
and fewer steaks.
But, in fact, what we can see is
that's the composition of a
substitution effect which is
negative, and an income effect
which is positive.
So if we do our standard
decomposition, we draw a new
monetary budget constraint
BC3.
It's parallel to the new budget
constraint, BC2, so the
same price ratio.
It's parallel.
But it's tangent to the old
indifference curve at point B
which is actually to the left
of the ultimate choice at
point C.
So the substitution effect
takes us from A to B. The
income effect actually takes us
back from B to C. That is
as that budget constraint shifts
from BC3 to BC2, as you
get poorer, you choose
more potatoes.
So the substitution effect would
say that from the price
change of potatoes alone, we go
all the way to point B. We
massively reduce our consumption
of potatoes.
But because we're poorer,
effectively, we now consume
more potatoes.
Because we're effectively
poorer, we now
consume more potatoes.
And so, on net, you get
a reduction in potato
consumption.
But it offsets the substitution
effect.
So that's when income effects
can be a little more
interesting.
It's going to be a little more
interesting exercise.
When you think about substitute
effects in the same
way, it's not that
interesting.
It's just look, quantity fell.
It doesn't really matter why.