income and substitution effects

When the price of something you buy falls, you usually end up buying more of it, but for two quite different reasons hiding inside that one response. Economists separate them into the substitution effect and the income effect, because pulling them apart explains why demand normally slopes down and reveals the rare cases where it does not.

The substitution effect is about relative cheapness: when coffee gets cheaper compared with tea, you switch toward the now-better deal and buy more coffee even if your real spending power had not changed at all. The income effect is about feeling richer: a lower coffee price means your same money stretches further, as if you got a small raise, and that extra real purchasing power changes how much of everything you buy. Picture tea dropping in price by half; first you swap toward tea because it is relatively cheaper (substitution), and then, because your budget now buys more overall, you adjust quantities again (income). The substitution effect always points toward the good that got cheaper; the income effect can go either way depending on the good.

This split is the deep reason the law of demand usually holds, and the careful exception that proves it. For a normal good, both effects push the same way, so a price cut clearly raises quantity bought. For an inferior good, the income effect works against the substitution effect, since feeling richer makes you want less of it. Only when an inferior good is so dominant in your spending that the backward income effect overwhelms the substitution effect do you get the strange Giffen good, where a price rise raises quantity demanded, a textbook rarity rather than an everyday event.