Substitution effect

In consumer theory, the substitution effect is the change in a consumer's chosen combination of goods attributable to a change in their relative prices, distinguished from the income effect, caused by the resulting change in purchasing power. A price change can therefore be decomposed into substitution and income effects. When the price of a good falls, the consumer's budget constraint changes and the movement to a new consumption bundle can be separated into these two components.

Graphically, the substitution effect is represented by a movement along the original indifference curve, while the income effect accounts for the subsequent movement to a different indifference curve. A related concept is the elasticity of substitution, for which John Hicks and Joan Robinson developed related definitions based on changes in the relative quantities and prices of factors of production.