Updated: Aug 20, 2021

The switching of consumption from one good or service to another in response to a change in the ratio of prices. Holding utility constant, the elasticity of substitution between two goods or services is the ratio of the proportional change in relative quantities consumed to the proportional change in relative prices. If the price of one good changes, the prices of all other goods being held constant, the change in demand can be divided into a substitution effect and an income effect. The substitution effect is the change in consumption holding the utility level constant: it shows how consumption would have changed if consumers had been compensated for the change in prices. See also elasticity of substitution; import substitution; marginal rate of substitution; substitution effect.

Reference: Oxford Press Dictonary of Economics, 5th edt.

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James Knight
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James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.