There are two effects to consumers demand when there is price dropped. These are the substitution effect and income
effect. Substitution Effect. It is said that when the price of a good rises, consumers will tend to substitute other goods for the more expensive goods in order to satisfy their desires more inexpensively. Example: People increasingly rely on electronic mail for correspondence because it is cheaper and quicker than regular mail. A price reduction creates an increase in disposable funds /real incomes (real income means the actual amount of goods and services that money can buy.) that the consumer can use to purchase more of some or all goods. Because a price cut releases income it resembles an increase in income. The substitution effect is the change in food consumption associated with a change in price of food with the level of satisfaction held constant. It captures the change in food consumption that occurs as a result of the price that makes the food relatively cheaper than the other goods. It measures the change in the quantity demanded due to a change in the price of good holding utility constant. It focuses on how a consumer respond when the price of good changes in such a way that his/her utility remains constant. Income Effect. The change in quantity demanded of goods due to the change in money income is an income effect. When a price rises and money incomes are fixed consumers’ real income fall because they cannot afford to buy the same quantity of goods as before. This produces the income effect, which denotes the impact of a price change on a goods’ quantity demanded due to the effect of the price change on real income. Because a lower real income generally leads to lower consumption, the income effect will normally reinforce the substitution effect.***