Income effect

It is normal for consumers to buy more of a good if its price falls. This effect can be further analysed by dividing it into:

The income effect occurs because, ceteris paribus, buying the same quantity of a good at a lower price will leave consumers with more income left over. Some of this income will then be spent on buying more of it, so the total quantity bought rises.

The income effect is positive for normal goods. It is negative for inferior goods, but in that case it is almost always more than offset by the substitution effect, so lower prices still mean higher consumption. The rare extreme cases where this is not true are called Giffen goods.

Although the income effect is defined differently from the income elasticity of demand, they will both have the same sign (positive or negative) for any particular good and income level. This is important in contexts such as classifying goods as inferior.

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