Substitution Elasticity

We may also take notice of another concept of elasticity, viz., substitution elasticity. In this connection, we make use of the concept of marginal rate of substitution already discussed in the indifference curve analysis.

The elasticity of substitution shows to what extent one commodity can be substituted for another without making any change in the total satisfaction derived by the consumer, i.e., he remains on the same indifference curve. In other words, the elasticity of substitution between two goods is the measure of the case or difficulty with which one commodity can be substituted for another. Just as price effect is the measure of price elasticity of demand similarly substitution effect measures the substitution elasticity of demand.

When the substitution of one good for another is difficult, then even a all change in the ratio of the two goods will bring about a great change in their marginal rate of substitution. If. on the lither hand. the substitution of one good fur another is cad)Chin a small change in their proportion with the consumer will not much change in their palliate of substitution.

Clear atlas we get an idea about elasticity from the interrelationship between the change in the proportion or the two goods with the consumer and as a result a change in their marginal rate of substitution. Elasticity of substitution.

The second component is the substitution effect. A fall in the price will lead to its substitution for other goods. The magnitude of the substitution effect depends on the elasticity of substitution, Es’ i.e., the extent to which X can be substituted for other goods on account of its becoming cheaper. This depends upon till) extent to which other goods already figure in consumption of the particular consumer. KX being the proposition of income that is spent on the good  is the proportion spent on other goods. This indicates the proportion spent on other goods. This indicates the limit to which other goods can be purchased; it shows the extent  sustainability and is thus the substitution effect.

Thus, price elasticity of demand depends upon
(a) proportion of income spent on the particular good
(b) Income Elasticity of demand
(c’) Elasticity of Substitution; and
(d) Proportion of income spent on the goods other than X.

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