The substitution effect is always negative. If price goes up, you want to buy less (and switch to something else). period.
The income effect depends on how much money is left over after the substitution effect. If the price of milk goes up by 10% and you cut gallons purchased by 5%, you are spending more money on milk -- correct. This is the income effect. It says you have less money to spend on everything else. (negative). However if you cut gallons by 20% then you are spending less on milk and have more money to spend on everything else. (positive)
What you spend on everything else depends on the character. For a normal good, the more income you have, the more you want to purchase (like t-bone steaks.) An inferior good has a negative relationship. As income goes up, the less you want to purchase. (Like gruel or oatmeal.)
Fact 1: "The substitution effect(SE) must ALWAYS be negative (i.e. goes in the opposite direction to the change in PRICE). The income effect(IE) can be either positive or negative."
Fact 2: "SE and IE can go in the same direction or they can go in opposite directions."
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1) Now, what does it MEAN to say that the INCOME effect is positive or negative? I simply do not understand this at all...it's very confusing...
2) When they say that "the substitution and income effects go in the SAME direction", does it mean that both the substitution and income effects are "negative"? (since SE is ALWAYS negative, if they go in the same direction, IE must also be "negative" as well.)
I am puzzled...can someone please explain?
Thank you very much!
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