The paper "The Substitution Effect and the Income Effect in Microeconomics" is an outstanding example of a micro and macroeconomic assignment. The utility is basically a hypothetical unit that is derived to ascertain the level of satisfaction that is derived from the consumption of a good. Now, Utility maximization is the instance whereby the satisfaction of the customers is maximized at their respective levels of consumption of the good. Now, this maximization can only be achieved if people have to pay for the good the price that they feel is pertinent and which most importantly, the customers are willing to pay.
Now, we introduce the concept of a budget constraint. A Budget constraint is basically representative of that optimal combination of goods that a consumer can purchase given current prices and the customer’ s respective income. Now, when we put these two conditions together, we arrive at a condition whereby at any given level of prices and income, the level of consumption of a good is at the exact price that the customer is willing and able to pay for that good and at that point utility of consumption is maximized i. e.
the greatest level of satisfaction can be realized at a given set of prices and income which inherently is the level of the product demanded at that given price and quantity. All of these points put together to become the demand curve of the good; therefore, we can say that the demand curve for a commodity can be derived from utility maximization subject to a budget constraint. The Substitution Effect: This effect is caused by the reaction of consumers with respect to the change in the price of a good in the quantity demanded of the good that arises due to the consumer altering between two closely substitutable goods.
For example, let’ s assume there are two good X and Y when the price of X would fall, the price of Y would become larger in comparison to X, and people would be more interested in the cheaper good X now that it is cheaper. This decision is based on the law of marginal returns i. e. good X can give the consumer the same satisfaction as good Y but at a lower cost, and the fact that market equilibrium is not being preserved by the consumer at this point in time.
Now, in the case where the price of good X falls, it's market marginal utility is on the rise, and the best strategy to cash in on this is to buy more units of good X.