Income effect
Topic: Consumer Behaviour, Demand and Elasticity · NCERT: Class 12, Ch 2 "Theory of Consumer Behaviour"
Meaning
The income effect is the part of a change in quantity demanded that comes from the change in the consumer's purchasing power (real income) when a good's price changes. When a price falls, her money income can buy more, so she feels richer. For a normal good, this raises demand. For an inferior good, it lowers demand. It is one of the two reasons the demand curve slopes down. The other is the substitution effect.
Example
Say bananas get cheaper while her income stays the same. She can now buy the same bananas and still have money left over. If bananas are a normal good, she spends some of that saving on more bananas.
Don't confuse with
- Substitution effect: a shift towards the good that has become relatively cheaper, at the same level of satisfaction. For a price fall it always raises demand. The income effect can go either way.
- Giffen good: this is the case where a negative income effect is stronger than the substitution effect, so demand rises with price.
Related concepts
- Law of demand
- Substitution effect
- Normal good
- Inferior good
- Giffen good
- Veblen good
- Conspicuous consumption
- Bandwagon effect
- Snob effect
- Demonstration effect