Substitution Effects and Steering-Wheel Daggers

Source: American Institute for Economic Research
by Donald J Boudreaux

“Non-economists readily understand income effects. These effects are those caused by changes in purchasing power — that is, by changes in wealth or income. Even seven-year-olds correctly realize that if their parents give them more money, they can buy more M&Ms. Conversely, seven-year-olds also are aware that if they lose some of their money, they can buy fewer M&Ms. Substitution effects are more subtle, although hardly difficult to grasp. These effects are those caused by changes in the relative attractiveness of different options. If the price of gummy bears rises while that of M&Ms doesn’t change, candy buyers — including seven-year-olds — will purchase fewer gummy bears and, quite likely, more M&Ms. This change in relative prices causes consumers to substitute out of gummy bears and into M&Ms.” (05/14/24)