The substitution effect occurs when consumers switch from a more expensive product to a similar, less expensive product. For example, if beef and chicken cost the same price, but beef begins rising in price, consumers will switch to the cheaper chicken. Chicken is a comparable alternative compared to beef and a better value.
Once the demand for beef drops, its price will drop as well. Consumers will then switch back to beef. It’s important to note that the substitution effect only works if consumers’ spending power remains the same. If consumers begin earning more, the substitution effect doesn’t impact their choice as much. Consumers are less likely to stop eating beef, even if the price rises.
Investment Property Wealth Management®
