INCOME EFFECT

by • 24/06/2011 • B.COM PART 1 EconomicsComments (0)1209


“Income effect may be defined as a measure of the change in the consumer’s equilibrium and in the quantity of goods purchased, solely due to a change in his money income; price of goods remaining constant.”

An increase in income of a consumer makes him to buy more of X and Y goods provide prices of both of them do not change. In the same way decrease in income causes him to buy less of X and Y. When income of a person increases, prices remaining the same, he purchase more units of X and Y, his satisfaction and welfare increases and vice versa. This situation is called Positive Income Effect.

Income Effect For Normal Goods

In case when both goods are normal, income effect is explained with help of diagram:

Income

Max. units of X

Max. units of Y

Budget Line

Equilibrium Point

10

10

10

AA

E

20

20

20

BB

E1

5

5

5

CC

E2

In the above diagram consumer has initial income level of Rs. 10 and he can purchase maximum 10 units of X and 10 units Y with budget line of AA and equilibrium will be on E where IC2 touches budget line AA. If income is increasing from 10 to 20 equilibrium will move on point E1 where IC3 touches budget BB. While income decreases from 10 to 5, the consumer equilibrium will move downward on point E2 where IC1 touches budget line CC.

Income Effect For Inferior Goods:

It is matter of common observation that when a person’s income is low, he is obliged to use inferior goods for subsistence, but as his income raises gradually, he uses less and less of inferior goods, which are substitute for the superior ones, this the income is negative or unfavorable in case of inferior goods, as illustrated in figure below:

The inferior good is Y, so that the ICC is inclined towards OX on which units of X are measured, showing that income increases, less and less of good Y is being bought.

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