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Social Sciences and History / Unit 13   SSH 1227 short lesson, about 20 seconds

Income Effect, Substitution Effect, Loss Aversion

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The idea

When a price rises, two effects always occur together. The substitution effect: buy less of the dearer good, more of the cheaper. The income effect: the buying power of income has fallen. Behavioral economics adds psychology: people value a dollar lost more than a dollar gained.

In practice

Over-withholding taxes to be sure of a refund.

Where people slip

Fungible: units equally valued; behavior says otherwise.

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