Income Effect
Another important item that can change is the money income of the consumer. The income effect is the phenomenon observed through changes in purchasing power. It reveals the change in quantity demanded brought by a change in real income (utility). Graphically, as long as the prices remain constant, changing the income will create a parallel shift of the budget constraint. Increasing the income will shift the budget constraint right since more of both can be bought, and decreasing income will shift it left.
Depending on the indifference curves, as income increases, the amount purchased of a good can either increase, decrease or stay the same. In the diagram below, good Y is a normal good since the amount purchased increased as the budget constraint shifted from BC1 to the higher income BC2. Good X is an inferior good since the amount bought decreased as the income increases.
is the change in the demand for good 1 when we change income from to, holding the price of good 1 fixed at :
Read more about this topic: Consumer Theory
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