INCOME EFFECT/Next/Next
| The case studies that are discussed here suggest how understanding the impact of income change on consumption is important in economic analysis.
(1) Expanding Middle Class and Rising Consumption in India The growth rate in India increased to above 7 percent, after the country adopted liberalization, privetization and globalization measures in the early 1990s. Growth of the middle class and its rising consumption levels have been important changes in the economy since 1990. However, the global crisis of 2009 hit the middle class by job losses and wealth erosion from the fall in the value of investment portfolios and property prices. This affected the changing lifestyle of the middle class adversoly. Thus income is an important determinant of a consumer's demand behaviour. For further details on India's changing lifestyle refer [1] and [2]
This study was conducted by Crisil, a rating agency, which examined increase in the prises of nontraditional protein-based food items in India during the period 2008-09 and 2010-2011. The study points at changing consumption preferences of the Indian buyers towards nontraditional protein-based food items from traditional protein-based food items, in the context of rising incomes, as a reason for rising prices of the former group. [3] |
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Key Terms |
Income Effect represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in her/his income and thereby changes in consumer's quantity purchased, price of goods remaining unchanged.
Positive Income Effect is obtained in the case of normal goods. It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in her/his income, and thereby changes in consumer's quantity purchased, prices of goods remaining unchanged.
In this case changes in the quantity demanded of a good is directly related to income changes.
Negative Income Effect is obtained in case of inferior goods (including Giffen goods). It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in her/his income, and thereby changes in consumer's quantity purchased, prices of goods remaining unchanged.
In this case changes in the quantity demanded of a good is inversely related to income changes.
Zero Income Effect is obtained in case of neutral goods. It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in her/his income and thereby changes in consumer's quantity purchased, prices of goods remaining unchanged.
In this case there are no changes in quantity demanded of the neutral good as a result of income changes.
Income Consumption Curve is obtained by joining the optimal consumption combinations of the consumer attained on the indifference map at alternative incomes. The ICC is a locus of a point that passes through optimal consumption combinations attained at alternative income, prices of goods remaining unchanged.In other words, an ICC traces changes in consumer's optimal consumption combination as a result of the income effect.
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Results |
- People respond to income changes in order to maximize the utility of spendable income. The income effect represents changes in optimal consumption combination on account of changes in income.
- In term of indifference curves, a consumer is better-off when optimal consumption combination shifts on a higher indifference curve and vice versa, as a result of an income change.
- Consumer’s responses to income changes vary depending upon the nature of goods.
- Income effect is positive, negative and zero for normal goods, inferior goods and neutral goods respectively.
- The varying responses of a consumer for normal goods, inferior goods and neutral goods to income changes are important determinants of different forms of market demand curves.
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Further Readings |
(1) Essays in Honour of Malcolm Sawyer Edited by Philip Arestis
(2)font size="2">› Visit Amazon's Dominick Salvatore Page
(3)Bradley R. Schiller (2011)The Micro Economy Today (11Edition) Tata McGraw-Hill
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