Question

Explain the substitution effects of a fall in the price of a commodity on its demand.

Answer 1

When the price of a commodity falls and prices of its substitutes remain unchanged, it becomes relatively cheaper in comparison to its substitutes. In other words, its substitutes become relatively costlier. Utility-maximising consumers will normally like to substitute cheaper goods for costlier ones. Thus, demand for the relatively cheaper commodity will increase. For instance, if the price of coffee falls, the price of tea remaining the same, coffee will become relatively cheaper. Coffee becomes more attractive to people in comparison with tea. Consumers would naturally shift from the consumption of tea to coffee. This increase in demand on account of a commodity becoming relatively cheaper is known as the substitution effect.