Definition of Income effect:
In microeconomics, the income effect is the change in demand for a good or service caused by a change in a consumer's purchasing power resulting from a change in real income. This change can be the result of a rise in wages etc., or because existing income is freed up by a decrease or increase in the price of a good that money is being spent on.
A change in the demand of a good or service, induced by a change in the consumers discretionary income.
Any increase or decrease in price correspondingly decreases or increases consumers discretionary income which, in turn, causes a lower or higher demand for the same or some other good or service. For example, if a consumer spends one-half of his or her income on bread alone, a fifty-percent decrease in the price of bread will increase the free money available to him or her by the same amount which he or she can spend in buying more bread or something else. It is one of the two effects caused by a price change; the other is substitution effect.
The income effect is a part of consumer choice theory—which relates preferences to consumption expenditures and consumer demand curves—that expresses how changes in relative market prices and incomes impact consumption patterns for consumer goods and services. For normal economic goods, when real consumer income rises, consumers will demand a greater quantity of goods for purchase.
How to use Income effect in a sentence?
- The income effect describes how the change in the price of a good can change the quantity that consumers will demand of that good and related goods, based on how the price change affects their real income.
- The change in the quantity demanded resulting from a change in price of a good can vary depending on the interaction of the income and substitution effects.
- I realized there would be an income effect and our items would sell less due to all the people in the neighborhood losing their jobs.
- You must always keep up with the income effect so that you can adjust your prices properly to maximize your profits.
- For inferior goods, the income effect dominates the substitution effect and leads consumers to purchase more of a good, and less of substitute goods, when the price rises.
- The income effect was substantial as their price elasticity was demonstrated to be a key factor in their decision making process.
Meaning of Income effect & Income effect Definition