Concepts of Income and Substitution Effects:
Change in demand for a good due to one unit change in price of that good for given prices and money income is known as own price effect for that good. Thus, own price effect =dx1/dp1 and it consists of own substitution effect and income effect for a price change.
Own Substitution Effect: Change in demand quantity for a good (say x1) due to change in its own price under constant real income (in terms of utility) is called substitution effect for that good and can be written as
Income Effect: Income effect for a good (say x1) represents change in demand quantity for that good for a change in real income. So income effect = ()ipdxdM , which is positive for a normal good, negative for inferior good and zero for neutral good.
Income Effect For A Price Change: For given money income, as price of any one good change one unit then real income (M/pi) changes for which demand for the good changes by income effect. It is known as income effect for a price change. Thus, income effect for a price change = . Note that income effect and income effect for a price change have opposite sign and different magnitude.