> #economics , #market-equilibrium > Discuss Substitution Effect & Income Effect by supporting your answer with graph. Explain how market disequilibrium become Equilibrium by supporting your answer with graph.?
Nov 19, 2023

# Discuss Substitution Effect & Income Effect by supporting your answer with graph. Explain how market disequilibrium become Equilibrium by supporting your answer with graph.?

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Nov 19, 2023
The substitution effect and income effect are two concepts used in economics to explain the changes in consumer behavior due to changes in prices or income.

The substitution effect refers to the change in consumption patterns that occur when the price of a good or service changes, while the consumer's income and the prices of other goods remain constant. It suggests that consumers will substitute a relatively cheaper good for a relatively more expensive one. This effect can be illustrated with a graph.

Let's consider a simple example of two goods, X and Y, and their respective prices, Px and Py. The initial budget constraint is represented by the line BC1 in the graph below, which shows all the combinations of X and Y that the consumer can afford given their income and the prices of the goods.

Graph:

```
Y
|
|
| BC1
|-------------------
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------------------- X
```

Now, if the price of good X decreases, the budget constraint will shift outward to BC2, as the consumer can now afford more of both goods. The substitution effect can be seen as the change in consumption from point A to point B, where the consumer substitutes good X for good Y due to the decrease in its price.

Graph:

```
Y
|
|
| BC2
|-------------------
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------------------- X
```

On the other hand, the income effect refers to the change in consumption patterns that occur when the consumer's income changes, while the prices of goods remain constant. It suggests that consumers will adjust their consumption based on changes in their purchasing power. This effect can also be illustrated with a graph.

Let's consider the same example as before, but now with a change in income. If the consumer's income increases, the budget constraint will shift outward to BC3, as the consumer can now afford more of both goods. The income effect can be seen as the change in consumption from point A to point C, where the consumer increases their consumption of both goods due to the increase in income.

Graph:

```
Y
|
|
| BC3
|-------------------
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------------------- X
```

Now, let's discuss how market disequilibrium becomes equilibrium using a supply and demand graph.

In a market, equilibrium occurs when the quantity demanded by consumers equals the quantity supplied by producers at a specific price. If there is a disequilibrium, either a surplus or a shortage will occur, leading to price adjustments until equilibrium is reached.

Let's consider a simple supply and demand graph for a good, where the price is represented on the vertical axis and the quantity is represented on the horizontal axis. The demand curve (D) slopes downward, indicating that as the price decreases, the quantity demanded increases. The supply curve (S) slopes upward, indicating that as the price increases, the quantity supplied increases.

Graph:

```
Price
|
|
| S
|-------------------
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