Editing Substitution effect (section)

==Graphical analysis==
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[[Image:Hicks Substitution effect.svg|Example of a substitution effect]]

Suppose the initial situation is given by the graph (with good Y plotted horizontally) with the indicated (and never-changing) [[indifference curve]]s shown and with [[budget constraint]] BC1 and with the consumer choosing point A because it puts him on the highest possible indifference curve consistent with BC1. The position and slope of the budget constraint are based on the consumer's income and on the prices of the two goods X and Y. If the price of Y falls, the budget constraint pivots to BC2, with a greater intercept of good Y because if all income were spent on Y more of it could be purchased at the now-lower price. The overall effect of the price change is that the consumer now chooses the consumption bundle at point C.

But the move from A to C can be decomposed into two parts. The '''substitution effect''' is the change that would occur if the consumer were required to remain on the original indifference curve; this is the move from A to B. The income effect is the simultaneous move from B to C that occurs because the lower price of one good in fact allows movement to a higher indifference curve. (In this graph Y is an inferior good since C is to the left of B so Y<sub>2</sub> < Y<sub>s</sub>.)