Substitution and Income Effects

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This paper investigates the impacts of a summer-long rise in gasoline prices. It examines the income effect and substitution effect across various scenarios to determine the most effective way for the author to offset the increased cost without adjusting their income. The study considers seven alternatives: reducing driving, decreasing expenditures on dining out, cutting back on maintenance spending, relying on public transportation, using bicycles, forgoing vacations, and reducing discretionary expenses. By utilizing graphs to depict the income effect and substitution effect, it becomes easier to identify the optimal solution.

This article investigates the impact of gasoline prices on individuals’ substitution and income effects. As an integral part of daily life, gasoline expenditure is a significant consideration. Currently, the author’s monthly gasoline expense is $120 for a duration of four weeks. Assuming a 100% surge in prices during one summer, the cost of fueling the same amount would reach $240 per month or $720 over three months (12 weeks). The automobile used achieves an efficiency of 30 miles per gallon of gasoline. During spring, gas costs $3.00 per gallon; however, this price escalates to $6.00 per gallon during summer. According to Thomas and Maurice (2011), consumers are negatively impacted when there is a rise in prices for goods (pp. 186-187). Consequently, adjusting the monthly budget becomes essential due to soaring gasoline expenses.To cope with these higher costs, evaluating either the substitution effect or income effect becomes necessary.Implementing sacrifices and managing finances effectively will enable the author to afford the increased gasoline prices.

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Drive Less

Driving less during the summer months can lead to money savings. This falls under the income effect, which refers to the change in consumption due to purchasing power changes after a price change (p. 188). For example, the author typically drives 50 miles to work for 5 days a week, 5 miles to the store twice a week, and 40 miles into town three times a week to meet friends. By carpooling and meeting friends closer to home, it is possible to reduce the distance by 20 percent.

Eat out Less

The author can observe the substitution effect by reducing their frequency of eating out in the summer in order to have enough money for gasoline. The substitution effect refers to the change in consumption of a good that occurs when its price changes, while the consumer stays on the same indifference curve (p 187). For example, if the author usually spends $80 per week on eating out with $5 meals and starts eating out half as much, spending $40 per week, they will save $40.

Less Maintenance on Automobile

One option for saving money and managing higher gasoline prices is to cut back on car maintenance expenses. This approach can be viewed as a means of boosting income. Rather than spending the typical $500 on pre-summer maintenance tasks like belt checks, tire rotation, oil changes, and air conditioning unit inspections, the author could opt for a more affordable alternative. They might decide to allocate only $100 specifically for an oil change and air conditioning check.

There is a $400 savings that can be applied towards the gasoline price increase. Substituting public transportation for driving a personal vehicle could result in significant cost savings. The cost of city transportation is only $1 per trip. Additionally, there would be savings in terms of automobile maintenance expenses. In comparison, driving for one month during the summer would cost $240, whereas taking 4 trips per day over a month (30 days) using public transportation would cost the same as a regular month of driving, $120.


Buying a bicycle necessitates an upfront payment of $100. Nonetheless, bicycles require less maintenance and eliminate the need for purchasing gasoline. They can be utilized for short-distance travel, acting as a substitute for a car in specific situations. Although not as versatile as public transportation, using a bicycle still results in savings. The author would still have to allocate funds for gasoline during their daily commute to work, which comprises approximately half of their gasoline budget. However, by opting to ride a bicycle for the other half of their commute time, they would save the corresponding amount on gasoline expenses.

Therefore, the overall cost, which includes buying the bicycle, would amount to $260 with the higher price, but it would remain $100 more than in spring. The author typically takes a summer vacation by driving to their preferred destination, resulting in an uptick in gasoline consumption and expenses for that vacation week. If the author opts out of taking a vacation, they could save money on both gasoline and the actual vacation expenditure. Furthermore, they would need less automobile maintenance.

This would result in both an income effect and a substitution effect. In addition to foregoing vacations, the author could also reduce shopping for clothing and decrease spending on groceries. By substituting already owned clothing and non-name brand foods, money can be saved to offset the increased cost of gasoline.


Various methods can be employed to counteract the effects of increased gasoline costs. These methods may include adjustments in income, substitutions, or a combination of both approaches.

These effects can be observed in various other instances, aside from the fluctuations in gasoline prices. In Canada, for example, there has been a 12 percentage point reduction in the rate of low income caused by market income effects (Picot, Lu, and Hou, 2010, p 13). Tokyo provides an interesting demonstration of the substitution effect. According to an article published in Economics Week, researchers have recently created cycles driven by expectations by balancing the wealth effect and the substitution effect resulting from anticipating higher future productivity (2010, p 30).

Both income and substitution effects are used worldwide to evaluate the best way to afford the rise in gasoline prices and determine the most advantageous outcomes. This paper focuses on analyzing the sacrifices that need to be made in order to afford the increase. Ultimately, when gas prices go up, both the substitution effect and the income effect decrease.


  1. Macroeconomics; New Data From I. Fujiwara et al Illuminate Research in Macroeconomics. (2010, May). Economics Week, 30. Retrieved June 14, 2010, from ABI/INFORM Global.
  2. Maurice, S. & Thomas, C. (2011). Managerial economics (10th ed. ). New York, NY: McGraw- Hill.
  3. Picot, G. , Lu, Y. , & Hou, F.. (2010). Immigrant Low-Income Rates: The Role of Market Income and Government Transfers. Perspectives on Labour and Income, 22(1), 13-21, 26-27. Retrieved June 14, 2010, from CBCA Complete.

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Substitution and Income Effects. (2018, May 17). Retrieved from

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