Income effect: Derivation of ICC and Engel Curve for Normal and Inferior Goods

Subject: Microeconomics

Overview

The income effect illustrates the whole impact of changes in consumer demand caused by changes in income at specific prices. It could be favorable or unfavorable. The link between the common commodities is favorable (either luxurious or necessities). Additionally, there is a bad correlation with the subpar items. The relationship between money revenue and money outlays is depicted by an Engel curve. With the aid of ICC, it is derivable. Engel's curve has a negative slope for subpar items and a positive slope for regular goods.

Income Effect and Derivation of Engel Curve

Given the prices of two items X and Y, it was assumed that the consumer's income level remained constant or unaltered in the consumer's equilibrium analysis. Given the pricing of the two goods, as well as the consumer's interests and preferences, the purchase decision will be affected if the consumer's income level changes (i.e., either increases or drops). The term "income effect" refers to this influence on demand or purchasing behavior. When all other factors are equal, the income effect depicts the overall impact on demand for goods caused by a change in consumer income.

Positive income effect:

It displays the overall impact on demand for common commodities caused by a change in the consumer's income level, while other factors are held constant or unaffected. The level of consumer income and the price of ordinary products are positively correlated. 

Negative income effect:

When a consumer reduces his consumption of a good as his income rises, this is known as a negative income effect for the good. These products are referred to as inferior goods when the income effect is negative. The consumer considers them to be somewhat "inferior" if their spending declines as their income increases. When a result, he replaces them with better products as his income increases. When a consumer's income rises, he starts to buy more better items, which results in a decrease in his consumption of or spending on lesser things. When people fall into poverty, they are unable to purchase superior items, which are sometimes more expensive. They turn to consuming superior as well as high or better quality goods when they become affluent and can afford to acquire more expensive goods.

The Engel curve and Income elasticity of Demand:

Since, Engel curve is the same as the income demand curves as it gives the quantity demanded of a commodity at various level of consumer's income. Therefore, following relationship between Engel curve and income elasticity of demand can be observed.

  • Engel curve slopes uphill and to the right if the good is normal luxurious, and ey is positive and greater than 1.
  • Engel curve slopes uphill and to the right if the good is a basic necessity, and ey is positive and less than 1.
  • Engel curve slopes downward and to the right if the good is an inferior, and ey is negative.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan

 
Things to remember
  • Given the pricing of the two goods, as well as the consumer's interests and preferences, the purchase decision will be affected if the consumer's income level changes (i.e., either increases or drops). The term "income effect" refers to this influence on demand or purchasing behavior.
  • When all else is equal, the income effect indicates that a change in consumer income has an overall impact on demand for goods.
  • Positive income effect indicates a comprehensive impact on demand for common items as a result of a change in the consumer's income level, while other factors remain the same or don't change.
  • The level of consumer income and the price of ordinary products are positively correlated.
  • When a consumer reduces his consumption of a good as his income rises, this is known as a negative income effect for the good. These products are referred to as inferior goods when the income effect is negative.
  • The consumer considers them to be somewhat "inferior" if their spending declines as their income increases. When a result, he replaces them with better products as his income increases.
  • When a consumer's income rises, he starts to purchase more better items, which results in a decrease in his consumption of or spending on lesser things.
  • When people fall into poverty, they are unable to purchase superior items, which are sometimes more expensive. They turn to consuming superior as well as high or better quality goods when they become affluent and can afford to acquire more expensive goods.

 

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