Price Changes: Income vs. Substitution Effects

Changing the price of one thing you buy can have literally zero effect on something else you buy.

Here's how. Imagine the price of your coffee goes way up. This makes you feel

a little poorer, so you might cut back on buying donuts. That's the income effect.

But at the same time, donuts are now *relatively* cheaper than your expensive coffee.

So, you're tempted to buy *more* donuts to make up for it. That's the substitution

effect. Sometimes, these two forces—feeling poorer and wanting to swap—can perfectly

cancel each other out. You end up buying the exact same number of donuts as before.