The Tale of Two Choices: Substitution and Income Effects

Rahul and Aman were best friends, both working in the same office but with different lifestyles. Every morning, they grabbed a coffee on their way to work—Rahul always went for his favorite artisan latte (₹250), while Aman preferred a regular filter coffee (₹100).

The Shock: A Price Hike!

One day, the café raised the price of artisan lattes from ₹250 to ₹350. Rahul frowned. “That’s expensive!” he thought.

This is where Substitution and Income Effects kicked in.

1. The Substitution Effect:

Since the artisan latte became more expensive, Rahul started considering alternatives. Instead of spending ₹350 daily, he thought,
"Maybe I’ll switch to a filter coffee like Aman—it’s much cheaper and still gives me my caffeine fix!"

🔹 Substitution Effect: When the price of a good increases, people look for cheaper alternatives (substitutes).

2. The Income Effect:

Rahul also realized that his purchasing power had decreased—even though his salary was the same, he now had less money left after buying his usual coffee.

So, he re-evaluated his spending habits. He thought,
"If my coffee is getting more expensive, I might need to cut down on weekend movies too."

🔹 Income Effect: When prices rise, people feel poorer and may cut back on purchases, even if their actual income hasn’t changed.

---

Normal Goods vs. Inferior Goods

The story doesn’t end here. Rahul and Aman’s choices reveal another key economic concept.

Normal Goods (Artisan Latte & Branded Coffee)

When people earn more, they buy more of expensive, high-quality products.

• Before the price hike, Rahul preferred artisan lattes—this is a normal good.
• If his salary increased, he would buy even more artisan lattes instead of switching to filter coffee.

Inferior Goods (Filter Coffee & Street Tea)

Aman, on the other hand, earned less than Rahul. If his income increased, he might stop drinking filter coffee and switch to something fancier.

• Filter coffee is an inferior good for him—he consumes less of it as his income rises.

🔹 Inferior Goods: Goods people buy less of when their income increases (e.g., instant noodles, budget bus rides).

---

Special Cases: Giffen & Veblen Goods

Rahul’s boss, Mr. Mehta, was a luxury enthusiast. He only drank imported, gold-infused cappuccinos. When the price of these fancy coffees increased, he bought even more of them—because for him, higher prices meant exclusivity and status.

🔹 Veblen Goods: Luxury goods where demand increases as price increases (e.g., designer brands, expensive cars).

Meanwhile, in rural areas, people relied on staple foods like rice and bread. When the price of rice increased, instead of buying less, they bought more, because they couldn’t afford anything else.

🔹 Giffen Goods: Essential goods where higher prices lead to higher demand, because there are no close substitutes.

---

Moral of the Story?

Our spending habits are shaped by how prices change and how rich we feel. Whether it’s coffee, luxury cars, or basic groceries, we all make decisions based on substitution and income effects, and whether a good is normal, inferior, Giffen, or Veblen.

So next time you hesitate before buying your favorite expensive coffee, ask yourself:
"Am I experiencing the substitution effect, the income effect, or just being a luxury-loving Veblen buyer?" ☕💸

[Economics]