You will substitute a good that falls in price for goods that rise in relative price. Additionally, when a good falls in price, the purchasing power of your income grows. These separate substitution effects and income effects can be graphically decomposed with indifference analysis.

 

In Figure 10, we initially assume that the price of asparagus is $2 per pound and our consumer is in equilibrium buying 100 pounds per week (point a). If the price of asparagus falls to $1 per pound, the new equilibrium is 280 pounds per week (point b). To split this total change into both income and substitution effects, we ask the following question: how much would she have purchased if the price fell but real income (satisfaction) remained constant?

 

We find this by plotting a new budget line that has the lower price for asparagus (parallel to the budget line where Pa = $1). This budget line is tangent to indifference curve I0 (keeping real income and satisfaction constant) at point c. This budget line reflects the change in relative prices and is parallel to the budget line tangent to point b. Thus, with no change in purchasing power, this consumer increases her purchases of asparagus to 200 pounds per week (point c) when the price drops to $1 per pound (the substitution effect equals 100 pounds). The remaining 80 pound increase in consumption is due to increased purchasing power (income) resulting from the price decline. The total change (180 pounds) thus equals the sum of the substitution effect (100 pounds) and the income effect (80 pounds).